We’ve written before about using LEAPs as a longer-term options strategy and as a substitute for buying a stock, but what we haven’t covered are the real basics of making your first LEAPs investment. It may come as a surprise, but a fairly recent analysis by Forbes found that slightly more than half of Americans have some exposure to equity investing (mostly through 401ks and retirement plans) and, citing the most recently available surveys from the Federal Reserve, found that less than 20% of U.S. households owned individual stocks.
Given those numbers, it’s likely that the percentage of Americans trading options is in the (probably low) single-digits. So today, lets run through the process of going from the starting line to your first LEAPs investment.
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LEAPs Investment Step #1: Education
Before making your first LEAPs investment (or any option trade) it’s important to take some time to educate yourself. We have both free and premium reports on options trading that offer an excellent primer on the strategies and fundamentals of options trading.
If you’re looking for a more interactive experience, the Chicago Board Options Exchange (Cboe) offers an Options Institute which features expert articles on options, live classes, and webinars. Additionally, your broker may have additional educational resources to help you learn the ins and outs of how options are priced and traded.
LEAPs Investment Step #2: Open and Fund Your Account
If you already have an existing brokerage account where you trade individual stocks you can probably skip this and move on to step three, but if you’re in the 81% of Americans that don’t have individual stocks, you’ll need to start by opening a brokerage account. Most brokerage firms like Merrill Edge, Schwab, or Robinhood allow you to easily open accounts online and link to external bank accounts to transfer funds.
If you’re not sure which firm is the right fit for you, start with your bank. If you have an account with a major financial institution, odds are they offer brokerage services. If that’s not an option, ask friends or family members that trade stocks for their recommendations. Brokerage firms have been racing to the bottom on fees, so no- or low-cost online trading is readily available across most major firms (there are still commissions on options, but most are nominal).
LEAPs Investment Step #3: Options Approval
Due to the unique risks and pricing of making a LEAPs investment, brokerage firms are required to conduct due diligence beyond the credit check that most conduct when opening account. Your broker will ask about your finances, your experience trading options (and that of any joint account holders), and the nature of your investing (conservative income, speculation, growth, etc.).
The best practice is to answer these questions honestly to ensure that the options approval “level” you receive aligns with your investing goals. For truly novice investors, your brokerage firm may only authorize you to sell covered calls against stocks you own. It can be frustrating when that happens but treat it as an opportunity to learn more and develop experience trading options.
LEAPs Investment Step #4: Find Your Stock or ETF
Ideally you already have a well-researched candidate in mind for your first LEAP investment. But if not, now’s the time to find one. There are a wide variety of factors to consider when analyzing a stock, and it’s beyond the scope of this article. You can use recommendations from analysts, your own fundamental or technical analysis or a combination of all three.
Because a LEAPs investment is longer term than a short-term speculative options trade, you’ll certainly want to target stocks that have strong fundamentals. Short-term noise can quickly move share prices, but big institutional investors that really drive the performance of the stock are more concerned with long-term fundamentals.
LEAPs Investment Step #5: Make Your Trade
You’ve opened and funded your account, secured options trading approval, and identified your target. Now it’s time to place that first trade. Because it’s your first trade, you may want to start with a lower investment than you’d typically make in an individual stock until you become more comfortable with the lower volume and higher spreads in options trading.
You’ll probably want to avoid placing a market order due to that lower volume, but if you’d like to place the equivalent of a market order, consider placing a limit order at the ask price. This will ensure that if you’re buying more than one contract, you won’t inadvertently buy up all the contracts at the current asking price and then receive executions above that. Lastly, as you trade, pay attention to your broker’s price improvement, which is their ability to execute your trades between the bid and the ask, which can save you hundreds of dollars through the course of trading.
Are you ready to make your first LEAPs investment?