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Rolling LEAP Options

The practice of extending the trading duration of holding options to the next trading period

What is Rolling LEAP Options?

Rolling LEAP options refers to extending the trading duration of holding options to the next trading period. It means investors roll options to manage a winning or losing position. In a losing position, they extend the time of trade to prevent losses before they close the position. However, they must possess sufficient and reliable data to support their decision. Otherwise, they stand to make more losses.

 

Rolling LEAP Options Diagram

 

If there is a sign of continuous improvement, there is no need to close the position. The prudent action will be to extend the trade. In either case, the ideal scenario might be, the price is quite close to where the investor wants it to be, but it’s promising. So, by extending the duration, the investor might make a higher gain than by locking it now.

 

LEAP Options vs. Shares

Before 1990, there were few choices in making quick money while trading. So, buying and selling stocks was the most favorable method compared to other financial securities. The only bargain was to speculate the stocks accurately. Unfortunately, if prices changed in a negative direction, traders incurred large losses. Another thing, it needed massive capital investment. However, with the introduction of options (LEAP), investors can now leverage long-term stocks opportunities as a buy-and-hold investment. Because of this, investors don’t need to make a large capital outlay on rolling leap options. Furthermore, the options offer short maturity periods ranging from six months to 3 years.

 

Understanding the Rolling LEAP Options Process

Rolling LEAP options involves simultaneously closing the existing position and opening a new position at a different strike price, with a different expiration, or both. Meaning, one LEAP option contract can replace another LEAP option contract by extending the expiration date. The process allows the option to continue compounding. And if the option has low volatility, the investor stands to have low-cost capital while having higher leverage and low-risk margins.

 

Example

Let’s say Joe is a savvy trader, and he is investing in LEAP trading. In the stock market, the strike price of Company X stocks is trading at $25 per share. Meaning, he owns the trading right of $25 per stock between the opening and expiration date. However, since he is trading options, he needs to pay a premium price of $2.05 per share. Since he wants to invest his $20,500 in the company, he buys 100 LEAP options contracts for a hold period of 1 year. Each contract, in this case, contains 100 shares. So, in total, he owns 10,000 shares (100 contracts x 100 shares/contract).

The total value of the shares is $250,000 ($25 per share x 10,000 shares). However, since he is trading contracts, he only needs to pay a premium fee of $20,500 ($2.05 premium price x 10,000 shares). For Joe to break even, a single share must trade at $27.05 ($25 strike price + $2.05 premium price). Therefore, to make a profit, Company X stocks must trade above $27.05.

Let’s say after six months the trade hits $30. Therefore, his profits margins might be $29,500 (($30 – 27.05) = $2.95 x 10,000 shares). But, if the share value deteriorates, Joe will lose money, and the only option is probably closing his position. However, if the expiration period is some few weeks to go and the figure is between $25 to $27.05, he might decide to either roll the LEAP to the next trading period in anticipation of an increase in share value.

 

When is the right time to roll a LEAP Option?

Rolling LEAPs is entirely a subjective discussion. There is no definitive guide regarding the right time to roll them. However, there are a few step investors may use to make sure they make sound judgments.

 

1. What were the investor’s initial assumptions?

That is, whether the current investor assumptions have changed from the initial state. For instance, if the initial assumption might have been the LEAP options will oversell, then the investor might have taken a contrarian position. However, if suddenly the investor becomes negative based on either price changes or position of the company like bankruptcy, then he/she might decide to sell-off his/her LEAP option at the expiration before incurring losses instead of profits.

 

2. The remaining amount of the extrinsic value in the trade

In any case, if the investors feel that they will not collect the credit, instead, they must pay the debt for rolling the trade, then, there will be no reason to extend the contract. However, if the option available is collecting the credit, then the investors will have an opportunity to earn more from the LEAP option investment.

 

3. Whether there is an opportunity to make a new lucrative trade if there was no position available

What essentially investors look forward in rolling a trade is closing the current trade and enter into a new trade in the hope of earning more than in the previous trade, which means they are taking on the loss. However, this depends whether the current trade is lucrative enough. If there are doubts, then it’s better to close it and invest elsewhere. Otherwise, it’s an opportunity for the next investment.

 

4. Define risk versus undefined risk

In defined risks, the higher the risks, the higher the returns, and the lower the risks, the lower the returns. However, in undefined trade risks, the LEAP option is naked – it is uncertain. In either case, when it comes to rolling risks, the best strategy is to use undefined risk. This is because there are no premium exposures to roll. As a result, the trader has the opportunity to keep the trade alive by buying more time for investing the money instead of taking the loss.

 

More resources

CFI is a provider of the Financial Modeling & Valuation Analyst (FMVA)™ certification program and financial analyst training. To keep advancing your career, the additional resources below will be useful:

  • Long and Short Positions
  • Daily Trading Limit
  • Trade Order Timing
  • Triangle Patterns – Technical Analysis

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