Protecting your capitol with leaps
Let us look at how it works. Let us say you own a stock that is trading at $118. The markets have been volatile lately and you are worried that they might crash along with your stock. To protect yourself you buy a $110 leap for $36. This gives you the right to sell the stock at $110 within 1 year. Now if the markets crash and your stock goes down to $50 you can still sell it at $110 because you bought the leap. Now let us say that the market didn’t crash but instead started to stabilize and even head up. Your stock went to $140. Your leap is only worth $18. You would have two choices in this instance. You can either do nothing with the leap and continue to have a protection level at $110, or if you feel like the markets are heading higher you can sell your $110 leap for $18. That allows you to receive back some of the premium you spent on protection. Buying leaps is definitely a helpful way for you to protect yourself from the downside but why would you buy them over short term put options they do the same thing and cost less. Let’s look at that. Now let us say that you did not want to buy the $110 leap but instead buy the $110 put. The $110 put only cost $6. The downside is it only gives you protection for one month. If after that month is over and you still want protection, you would have to buy another $110 put for the next month. So, you can wind up paying $6 a month per share for protection as long as you feel the market is uncertain. With the leap you would only pay $3 a month because $36/12= $3. This could be helpful if you are looking at protecting your capitol over a longer period of time. |
