LEAPS Covered Calls

LEAPS covered calls are much like other stock covered call options that investors can use to generate cash income in their stock brokerage accounts, but with one important difference.  The difference is that LEAPS, or Long Term Equity AnticiPation Securities, have expiration dates longer than one year.  An example might help to explain how to use LEAPS covered calls to your advantage.

First, if you are not familiar with options trading, a call option gives the buyer the right, but not the obligation, to buy a pre-determined quantity of an asset, usually a stock or commodity, at the specified price (strike price), on or before the expiration date of the option contract.  A covered call  option is just a standard call option where the seller is covering the contract with securities that are already owned in their brokerage account.  LEAPS covered calls are standardized call option contracts with expiration dates over one year away, that are secured by the shares of stock that are already owned in the sellers trading account.  Since each LEAP option contract represents 100 shares of stock, these covered options can only be sold (also known as writing a call option) based on full 100 share increments of the underlying stock that the option is being written against.  For example, if an investor holds 200 shares of General Electric (GE) in their brokerage account, they would be able to write (or sell) 2 LEAPS covered calls.

The longer expiration dates that LEAPs possess give long term investors the ability to get exposure to long term price changes, with no need for a combination of shorter-term option contracts. Also, the premiums (price) for LEAPs are higher than for standard options in the same stock because the increased expiration date gives the underlying stock more time to make a large price move and for the investors to make a good profits.  Conversely, for the investor writing LEAPS covered calls, they get a higher cash payment up front for taking on the risk that they may be called out of their stock over the longer time frame contained in the covered LEAP contract.

One other characteristic that an investor considering writing LEAPS covered calls should consider is that the price decay of a LEAP call option is much slower than an option with a much nearer term expiration date.  For instance, if a call option with a strike price  equal to the underlying stocks current price only has a month to expiration, and the underlying stock price stays flat, the price of the call option will decline to nothing over the final month of the contract.  However, a leap contract will register a very minimal reduction in price over the same month, due to it’s longer time to expiration.

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Stock covered calls are a technique use by stock market investors to generate additional income from stocks that they already own in their investment portfolios.  While options trading may sound scary, this technique for generating income is actually so conservative that most brokers will even let you utilize this technique in your online Individual Retirement Account (IRA).

A call option gives the buyer the right to buy a pre-determined quantity of an asset, usually a stock or commodity, at a specified price (strike price), on or before the expiration date of the option contract.  A covered call option is a standard call option that the seller is covering with securities that are already owned in his trading account.  Stock covered calls are merely standardized call options that are secured by the shares of stock that are already owned in the sellers trading account.  Since each option contract represents 100 shares of stock, these covered option calls can only be sold (also known as writing a call option) based on full 100 share increments of the underlying stock that the option is being written against.  For example, if an investor holds 670 shares of Cisco Systems (CSCO) in their account, they would be able to write (or sell) 6 stock covered calls.

Now that we’ve gone over what stock covered calls are, lets look at how to use them.  Lets continue with the example of the investor with 670 shares of CSCO in their stock market investing account.  Since CSCO does not pay a dividend, and the investor wants income without having to sell his stock, he decides to sell call options that will expire in two months, for a price that is above todays stock price for CSCO.  In return for this option, the investor gets $1 per share, or $100 per covered option calls contract, times 6 contracts equals $600.  This cash is deposited directly into the investors trading account, and can be used for whatever purpose the investor chooses.  The investor is now obligated to sell the contract holder 600 shares of stock at the price specified in the contract, on or before the expiration date of the contract. 

Now if the stock price does not go above the contract strike price, the investor who sold the option contracts keeps his stock, and the cash he got from selling the stock covered calls, and can do it all over again on the trading day after the contract expires.  This is a very powerful concept, since it means that the investor can generate income multiple times per year by selling these call options. 

If the stock closes above the price specified in the contract, usually around the date the contract expires, the contract will be exercised by the option holder, and the investor will have to sell him the 600 shares of CSCO at the price specified in the option contract.  Since the contract price is above the price that the stock was trading at when the options were sold, the investor gets that capital gain profit, plus the cash that he was paid for selling the options.

While stock covered calls may seem a little complicated at first, in the end they provide you with a relatively easy way to generate cash flow on stocks that would otherwise just be sitting in your investment account.

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Stock Options Basics

Put options give an option buyer the right to sell 100 shares of an underlying stock at the strike price that the option contract was written for. While the put option buyer is not obligated to exercise the contract, if the buyer does exercise the contract, the option seller is obligated to pay the contract price for 100 shares of the underlying stock from the contract buyer, on or before the expiration date of the contract. Put option buyers are betting that the price of the underlying stock will move down. A put option becomes more valuable when the price of the underlying stock goes down.

are one of the most versatile trading vehicles available. Options on stocks are highly leveraged derivative investments, with a very well defined risk/reward profile.

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