25 lines
1.7 KiB
Plaintext
25 lines
1.7 KiB
Plaintext
LEAPS
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Options buyers have time working against them. With each passing day,
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theta erodes the value of their assets. Buying a long-term option, or a
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LEAPS, helps combat erosion because long-term options can decay at a
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slower rate. In environments where there is interest rate uncertainty,
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however, LEAPS traders have to think about more than the rate of decay.
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Consider two traders: Jason and Susanne. Both are bullish on XYZ Corp.
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(XYZ), which is trading at $59.95 per share. Jason decides to buy a May 60
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call at 1.60, and Susanne buys a LEAPS 60 call at 7.60. In this example,
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May options have 44 days until expiration, and the LEAPS have 639 days.
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Both of these trades are bullish, but the traders most likely had slightly
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different ideas about time, volatility, and interest rates when they decided
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which option to buy. Exhibit 7.1 compares XYZ short-term at-the-money
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calls with XYZ LEAPS ATM calls.
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EXHIBIT 7.1 XYZ short-term call vs. LEAPS call.
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To begin with, it appears that Susanne was allowing quite a bit of time for
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her forecast to be realized—almost two years. Jason, however, was looking
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for short-term price appreciation. Concerns about time decay may have
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been a motivation for Susanne to choose a long-term option—her theta of
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0.01 is half Jason’s, which is 0.02. With only 44 days until expiration, the
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theta of Jason’s May call will begin to rise sharply as expiration draws near.
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But the trade-off of lower time decay is lower gamma. At the current
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stock price, Susanne has a higher delta. If the XYZ stock price rises $2, the
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gamma of the May call will cause Jason’s delta to creep higher than
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Susanne’s. At $62, the delta for the May 60s would be about 0.78, whereas |