Introduction:
I have been trading options for about 14 years and because of the market conditions I was contemplating buying some Leap Options. So I decided that these unusual options would be a good educational topic for this Community, and a good review of the trading concepts.
First, what are Options
An option is an investment vehicle, but also a contract, which gives you the legal right, but not the obligation, to buy or sell a security at a certain price, within a certain times period, in return for a fee, per share, called a premium. And stock options must be purchased in groups of one hundred, called contracts.
Second, what are Calls? A specific type of option
This is an option which gives you the right, but not the obligation, to buy a security at a certain price, within a certain times period, for a fee per share called a premium, and are purchased in groups of one hundred called contracts.
Third, what are Leaps? A specific type of Call Option
Definition: A Leap is a special type of Call Option named Long Term Equity Anticipation Security. But options traders and most options exchanges refer to them as Leaps. So as you can see they are basically Call Options with really long expiration periods of up to one year or more, versus the usual 7 day, 14 day, 28 day or 45-61 day option expiration cycle.
What Leap options am I thinking of buying? .
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Bitcoin Leaps
Bitcoin Leap is a call option which gives you the right, but not the obligation, to buy a security at a certain price, for a fee per share called a premium, and are purchased in groups of one hundred called contracts, but the expiration period is very, very long, up to a year.
Why?
Options give you leverage. For a fraction of the cost of owning one Bitcoin at 23,000 USD you can control one Bitcoin for 2300 USD. So you could actually control ten Bitcoin for 23,000 USD.
Why do you want to control and not own?
Leverage and profit multiples.
Example:
Robert owns one tenth bitcoin (0.1 BTC) at a cost of $2300 USD
If the price of Bitcoin doubles in one year, his BTC is worth $4600 USD
His profit is 4600-2300 or $2300
Richard owns one Bitcoin LEAP option, which allow him to control one Bitcoin valued at $23,000 USD, and his Leap Option cost $2300.00.
If the price of Bitcoin doubles his Bitcoin is now worth $46,000 USD
His profit is $46,000-2300= $43,700
Robert owns 1/10 Bitcoin and Richard controls ten times as much or a whole Bitcoin. Richard's profit is almost 20x as great as Roberts. This is called leverage. But options are not all good, there is a bad side, there are risks.
Risks and benefits
Benefits
As you can see Richard owned a call option, which allowed him to control ten times as much Bitcoin as Robert for the same cost. So his profit was ten times as great, for the same cost. This is called leverage.
Risks
However...there are risks. If you own Bitcoin you have an unlimited amount of time to wait to take your profit. If you own the option you have a limited period of time for the Bitcoin to go up in price, so you can make a profit. If it doesn't go up in price, your option expires worthless and you lose your $2300 dollars.
So while Robert owned only 1/10 as much Bitcoin, he has a better chance of making a profit, long term. While Richard has the chance to make ten times as much profit, he also has a bigger risk then Robert of losing his entire investment.
If you bought Bitcoin at the beginning of the last Bear Market 2018 and held until now you would have made money. But if you bought the option, your option probably would have expired worthless during the long bear market. Alternatively if you bought Bitcoin options at the start of 2021 you could sell them now for a big profit.
In retrospect it's easy to see the wisdom or folly of each choice. But in real life it's not so clear. In options trading we call this buying yourself enough time to be right about the direction of the assets movement.
Final Words
The options strategy has a chance to multiple your profits, but it also can consume your entire capitol and leave you with nothing. So before entering a trade you need to assess the underlying asset and determine the probability of it rising to a price which is profitable. And always buy yourself enough time to be right.
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title: Option Trading Topics: What are Leap Options?