One of the best aspects of options investing is the ability to tailor your trades to a variety of market conditions. You can buy calls when you’re bullish, puts when you’re bearish and enter into other, more complicated trades if you fall somewhere in the middle. One of the more effective LEAPs strategies for use in an uncertain market is taking a bullish or bearish position and then selling higher- or lower-strike options against that position.
These LEAPs strategies allow you to specifically limit your downside risk while recouping some of your initial cost. Given the lack of current direction in the broader market, let’s break down two LEAPs strategies that you can use based on your intermediate- to longer-term sentiment.
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LEAPs Strategies for Bullish Investors: The Bull Call Spread
The bull call spread is one of the simpler LEAPs strategies for bullish investors as it involves a single trade in two calls. We’ll be using the SPDR S&P 500 ETF (SPY) for this example due to high liquidity in both the options and underlying security. This is a bullish trade which requires that you expect the market to trade higher over the next six or seven months. With a bull call spread you purchase a call with a lower strike (and higher price) and sell a partially offsetting call with a higher strike (and lower price).
For instance, an investor that believes the S&P 500 could return an additional 6-10% through the remainder of the year could buy a January 21, 2022 call with a strike price of 425 for approximately $18.50 and sell a call with the same expiration and a 450 strike price for about $6.50.
The net cost of $12 (or $1,200 per contract) represents the maximum loss on the trade.
This trade breaks even if SPY is trading at 437 on expiration.
The maximum profit on this trade is 108% should SPY trade at or above 450.
The trade is profitable should SPY trade anywhere between the breakeven of 437 and the maximum profit at 450.
LEAPs Strategies for Bearish Investors: The Bear Put Spread
The bear put spread is also among the simplest LEAPs strategies as it involves one trade in two puts. This trade would be used by investors who are broadly bearish and expect the market to decline through the remainder of the year. With a bear put spread you purchase a put with a higher strike (and higher price) and sell a put with a lower strike (and lower price).
An investor who expects the S&P 500 to lose 6-10% by January could purchase a put with the same January expiration and a strike price of 420 for approximately $20.25 and sell a put with a strike price of 395 for approximately $13.50.
The net cost of $6.75 (or $675 per contract) represents the maximum loss on the trade.
This trade breaks even if SPY is trading at 413.25 on expiration.
The maximum profit on this trade is 270% should SPY trade at or below 395.
The trade is profitable should SPY trade anywhere between the breakeven of 413.25 and the maximum profit at 395.
There are other, more complicated LEAPs strategies that can allow you to generate returns against a long call or put which we will likely cover in the future. However, if you’re interested in taking either a bullish or bearish position for the longer term while also mitigating some of the costs of the trade, a spread can be an excellent choice.
What degree of options trading are you comfortable with, and have you taken steps to learn more about LEAPs strategies?