Investing in Growth Stocks using LEAPS®

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.

LEAPS®, or Long-term Equity Anticipation Securities, are long-term stock or index options that expire more than 9 months in advance, and can last as long as 2 to 3 years. They are significantly cheaper to own than the underlying stocks and possess what I consider to be built-in stop-loss protection.

If you believe that a stock is a potential multi-bagger in 2 to 3 years time, then buying slightly out-of-the-money LEAPS® calls is a solid strategy that offers the important benefits of leverage and downside protection. To see how LEAPS® are able to offer the benefits I just highlighted, let's consider some of the characteristics of high growth stocks.

First of all, they are expensive. As these companies have been growing for the past few quarters, their price/earning ratios are usually very high as market expectations are high. This also means that a single quarter of missed earnings, no matter how minor, can potentially cause the market to overreact and the stock price to come crashing down - not too cool if you are holding on to the stocks. With LEAPS® however, your loss is limited to the premiums paid for the options.

On the flip side, should this stock turn out to be the multi-bagger as you had envisioned, you are looking at enormous returns on investment. This is because LEAPS® cost a fraction of the price of the stock and a tripling of the underlying stock price will result in an ROI exceeding 1000%, turning a 3-bagger into a 10-bagger!

The primary concern with owning LEAPS® is that like all options, they are wasting assets. However, I personally think that if your potential multi-bagger fails to achieve stardom in 2 to 3 years time, then chances are that it will never achieve the greatness and when that piece of information sinks in with the investors, the market will usually be pretty hard on the stock price. This is not uncommon. I’ve witness prices of hot stocks plummet from the fifties to single digits in a matter of weeks. Good thing you are holding on to the LEAPS® instead.

Probably the most unfortunate issue with LEAPS® is that they are usually available only for popular stocks and are seldom traded for small cap stocks - the stage where most of the potential ten baggers are hiding in.

More Articles

  1. Buying Straddles into Earnings
  2. Day Trading using Options
  3. Writing Puts to Purchase Stocks
  4. Dividend Capture using Covered Calls
  5. Effect of Dividends on Option Pricing
  6. Leverage using Calls, Not Margin Calls
  7. Bull Call Spread: An Alternative to the Covered Call
  8. Understanding the Put-Call Parity
  9. Difference between a Futures Contract and a Forward Contract

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Buying Straddles into Earnings

Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results....[Read on...]

Writing Puts to Purchase Stocks

If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount....[Read on...]

Investing in Growth Stocks using LEAPS® options

If you are investing the Peter Lynch style, trying to predict the next multi-bagger, then you would want to find out more about LEAPS® and why I consider them to be a great option for investing in the next Microsoft®.... [Read on...]

Effect of Dividends on Option Pricing

Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date....[Read on...]

Bull Call Spread: An Alternative to the Covered Call

As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative....[Read on...]

Dividend Capture using Covered Calls

Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the ex-dividend date....[Read on...]

Leverage using Calls, Not Margin Calls

To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin....[Read on...]

Day Trading using Options

Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading.... [Read on...]

What is the Put Call Ratio and How to Use It

Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator.... [Read on...]

Understanding Put-Call Parity

Put-call parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa.... [Read on...]

Understanding the Greeks

In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as "the greeks".... [Read on...]

Valuing Common Stock using Discounted Cash Flow Analysis

Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow.... [Read on...]

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