Investing Assets & Markets Stocks Investing With Long-Term Equity Anticipation Securities (LEAPS) A Risky Options Strategy for Experienced Investors By Joshua Kennon Joshua Kennon Twitter Website Joshua Kennon is an expert on investing, assets and markets, and retirement planning. He is the managing director and co-founder of Kennon-Green & Co., an asset management firm. learn about our editorial policies Updated on December 6, 2022 Reviewed by Chip Stapleton Fact checked by Aaron Johnson In This Article View All In This Article What Are LEAPS? How Investing With LEAPS Works The Result of Investing With LEAPS Risks of Investing With LEAPS Frequently Asked Questions (FAQs) Photo: Lechatnoir / Getty Images Investing with long-term equity anticipation securities (LEAPS) may be a good strategy if you're bullish on a particular company’s stock, but this type of investment comes with many risks. A rise of 50% could translate into a 300% gain, but a drop could mean significant losses. LEAPS could wipe out your entire portfolio in a matter of days if not used the right way. On the flip side, LEAPS can be a powerful tool that allows you to leverage your investment returns without borrowing money on margin. Key Takeaways Using long-term equity anticipation securities (LEAPS) with an expiration period of up to three years can be an alternative to buying stocks outright.Using LEAPS can result in huge returns, but they can be risky, resulting in significant losses.LEAPS may make sense if you believe that a stock will be worth much more than the current market price before your options expire.Using LEAPS shouldn’t be considered if you can’t sustain significant losses to your investment portfolio. What Are LEAPS? LEAPS is the acronym for long-term equity anticipation securities, a type of investment option with an expiration period of up to three years. Investing with LEAPS allows you to use less capital than you would if you were purchasing stock, and they can deliver outsized returns if you bet right on the direction of the shares. How Investing With LEAPS Works Let's look at an example. Suppose you want to purchase several shares of Company XYZ. It's trading at $14.50 per share, and you have $14,500 to invest. You're convinced that XYZ will be substantially higher within a year or two, so you want to invest your money in the stock. You have three investment strategies to choose from: Purchase the stock outrightBuy it on marginUse LEAPS Note Buying on margin involves borrowing money from your broker and pledging your shares as collateral for the loan. It might sound convenient, but you could ultimately lose more money than you've invested. Buying a Stock Outright or on Margin You could simply buy 1,000 shares of the stock outright with your $14,500, or you could leverage yourself 2:1 by borrowing on margin, bringing your total investment to $29,000 and 2,000 shares of stock with an offsetting debt of $14,500. But you could be forced to sell at a loss if you were to get a margin call, if the stock were to crash, or if you were unable to come up with funds from another source to deposit into your account. Note When you borrow money on margin, you'll be required to pay interest to your broker. Using LEAPS You might consider using LEAPS instead of the common stock if you don't like this level of exposure. First, you would look at the pricing tables published by Cboe and see that you can purchase a call option for Company XYZ that expires two years from now, with a strike price of $17.50. That means you have the right to buy at $17.50 per share at any time between the purchase date and the expiration date. You must pay a fee (known as a premium) for this option. The call options are also sold in contracts of 100 shares each. Note A call option gives you a defined period of time during which you can buy shares at the strike price. Suppose you decide to take your $14,500 and purchase 100 contracts. Remember that each contract covers 100 shares, so you would then have exposure to 10,000 shares of Company XYZ using your LEAPS. Suppose you pay a premium of $1.50 per share. That's $1.50 times 10,000 shares, or $15,000. You round up to the nearest available figure to your investment goal, but the stock currently trades at $14.50 per share. You have the right to buy it at $17.50 per share, and you paid $1.50 per share for that right, so your breakeven point is $19 per share. This scenario could play out in any of a few different ways: You'll suffer some loss of capital if the stock trades between $17.51 and $19 per share when the option expires in two yearsYou'll have a 100% loss of capital if it trades below your $17.50 call strike priceYou could call your broker and close out your position if the stock does rise substantiallyYou could force someone to sell you the stock for $17.50 per share if it rises above that, and then immediately turn around and sell the shares you bought at the higher price per share if you elect to exercise your options. You'd pocket the difference per share—the capital gain above $17.50 minus the $1.50 you paid for the option. The Result of Investing With LEAPS If the share price rose to $25, your net profit on the transaction would be $6 per share on an investment of only $1.50 per share ($25 - $17.50 = $7.50 - $1.50 = $6). You turned a 72.4% rise in stock price ($25 - $14.50) into a 400% gain by using LEAPS instead. Your risk was certainly increased, but you were compensated for it, given the potential for outsized returns. Your gain would work out to $60,000 ($6 capital gain per share on 10,000 shares) for an initial investment of just $15,000, compared to the $10,500 you would have earned if you had bought 1,000 shares of the stock outright at a share price of $14.50, and it increased to $25 per share over time. Buying it on margin would have helped you earn $21,000, but you would have avoided the potential for wipe-out risk because anything above your purchase price of $14.50 would have been a gain. You would have received cash dividends during your holding period, but you would have been forced to pay interest on the margin you would have borrowed from your broker. It's also possible that you could have been subject to the margin call if the market had tanked. Risks of Investing With LEAPS Using LEAPS doesn't make sense for most investors. You should only use LEAPS if you have the ability to lose money without it impacting your financial situation. Use caution and consider these factors before investing with LEAPS: You have experience with strategic tradingYou have excess cash to spare and can afford to lose every penny you put into the marketYou have a complete portfolio that won’t miss a beat by the losses generated in such an aggressive strategy Note The biggest temptation when using LEAPS is to turn an otherwise good investment opportunity into a high-risk gamble by selecting options that have unfavorable pricing or would take a near miracle to hit the strike price. You might also be tempted to take on more time risk by choosing less-expensive, shorter-duration options that are no longer considered LEAPS. The temptation is fueled by the extraordinarily rare instances when an investor has earned a very large return. Frequently Asked Questions (FAQs) How do you buy LEAPS? To buy LEAPS, you'll need a brokerage account with permission to buy call options contracts. It's up to each brokerage to decide when to let you buy calls, but the factors in their decision will include your experience as a trader and your total equity in the account. How are LEAP options taxed? Just like holding stocks outright, LEAPS are eligible for the more favorable long-term capital gains tax rate. Most of those who hold onto a LEAPS option for more than one year before selling are taxed at either 0% or 15% (though high-income individuals may be taxed up to 20%). The gains from LEAPS sold exactly one year after buying (or sooner) are taxed at your normal income rate. When do new LEAPS come out? New LEAPS come out a little more than two years before the calendar year of expiration. For example, LEAPS options that expire in 2024 were released in late 2021. LEAPS that expire in 2025 were released in late 2022. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. Cboe. "LEAPS Options." U.S. Securities and Exchange Commission. "Margin: Borrowing Money To Pay for Stocks." U.S. Securities and Exchange Commission. "Investor Bulletin: An Introduction to Options." FINRA. "FINRA Reminds Members About Options Account Approval, Supervision and Margin Requirements." IRS. "Topic No. 409 Capital Gains and Losses." The Options Industry Council (OIC). "LEAPS & Expiration Cycles."