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For long positions, I think we're in a golden era for deep ITM LEAP calls. Some advantages:
1. Leaps are interest-rate sensitive. For calls, lower interest rate = cheaper, higher interest rate = more expensive. Going long LEAPs is a way to help hedge against risk of
rates at
1. Leaps are interest-rate sensitive. For calls, lower interest rate = cheaper, higher interest rate = more expensive. Going long LEAPs is a way to help hedge against risk of
rates at
these bottom levels, and there's (presumably) little risk of rates going lower.
2. LEAPs have relatively high vegas, meaning that they benefit from increases in implied volatility. There is reason to believe markets will be increasingly volatile going forward. LEAPs are a way
2. LEAPs have relatively high vegas, meaning that they benefit from increases in implied volatility. There is reason to believe markets will be increasingly volatile going forward. LEAPs are a way
to get long volatility exposure. It even helps on downward shocks: when a vol event occurs that shocks to the downside, the increase in volatility will offset some (sometimes all) of the loss in the underlying. This is especially true since the less ITM that the option is, the
higher its vega, meaning the more the stock goes down, the more volatility will boost the LEAP price.
3. The nature of long calls is that their delta (sensitivity to price changes in the stock) goes up as the call becomes more ITM, and goes down as the call becomes less ITM.
3. The nature of long calls is that their delta (sensitivity to price changes in the stock) goes up as the call becomes more ITM, and goes down as the call becomes less ITM.
This means that your position becomes more sensitive to price changes as it rallies, and less sensitive as it falls. I find this a favorable risk control mechanism since it means that your position rises faster than it falls point for point.
4. There are a number of dividend
4. There are a number of dividend
yielding stocks at low valuations. For example (ESG opinions aside), $MO is frequently discussed as among the cheapest blue chips out there. Call pricing discounts dividends, meaning that you pay less for calls on dividend paying stocks. Case in point, $MO Jan 20 '23
calls have been trading around $11.25 today, meaning that their breakeven point on expiration in 2023 is $41.25, a mere 1.8% above current share price. Additionally, as discussed in my last tweet, you can sell shorter term calls against your LEAP position. For example, you
could sell the Feb 19 '21 42 calls for ~.43, driving down the cost basis on your leaps to ~$10.75 while leaving meaningful upside in the next few weeks.
5. Of course, the leverage aspect can be powerful. Using the $MO example above, a return to Jan '20 price levels of ~$50
5. Of course, the leverage aspect can be powerful. Using the $MO example above, a return to Jan '20 price levels of ~$50
would be a ~25% return on the stock, while an almost 100% return on $30 the LEAPs.
Ofc, there are downsides: you don't get dividends, you have less of a margin of safety on total loss, and if IV is elevated at time of purchase, compression will hurt you. But I continue to
Ofc, there are downsides: you don't get dividends, you have less of a margin of safety on total loss, and if IV is elevated at time of purchase, compression will hurt you. But I continue to
believe LEAPs have underappreciated benefits with unusually low risk in this incredibly low interest rate environment. I promise, my last tweet on LEAPs for a while!
Also wanted to add @Rationalbiased 's great thread on ITM LEAPs, which additionally discusses useful concepts like put-call parity and why options can provide leverage with advantages over margin: https://twitter.com/Rationalbiased/status/1346576123946270722?s=20
