LEAPS vs. Short-Term Options
Options, in general, give you the right, but not the obligation, to buy (call option) or sell (put option) an underlying asset (like a stock, ETF, or index) at a predetermined price (the strike price) before a specific expiration date.
This “right” comes at a cost, called the premium.
Where LEAPS and short-term options diverge dramatically is that expiration date, and that difference ripples through every aspect of their use.
Key Takeaways – LEAPS vs. Short-Term Options
- Time Decay Battle
- Short-term options face rapid time decay (theta), making them a race against the clock.
- LEAPS have slower decay, providing more time for your investment thesis to play out, but cost more upfront.
- Leverage & Risk
- Short-term options offer higher leverage, amplifying potential gains and losses significantly.
- LEAPS provide less leverage but still offer more control than buying shares outright, creating a different risk/reward balance.
- Volatility Impact
- Short-term options are highly sensitive to volatility changes (vega).
- LEAPS are less affected by short-term volatility swings, focusing more on long-term implied volatility.
- Strategic Fit
- Use short-term options for income generation (selling), hedging, or speculating on quick price moves. Best for day trading.
- Choose LEAPS for long-term directional bets, stock replacement strategies, or when lower time-decay pressure is desired.
What are LEAPS?
LEAPS stands for Long-Term Equity Anticipation Securities. That’s a mouthful, so we stick with LEAPS.
These are options contracts with expiration dates ranging from one year to over three years in the future.
Think of them as long-term bets on the underlying asset’s price movement.
What are Short-Term Options?
Short-term options, conversely, have expiration dates ranging from a few days to a few months.
They offer the potential for quick gains (and, of course, quick losses).
They are commonly referred to as “weeklies” or “monthlies,” depending on their duration.
Dailies – i.e., O DTEs – are also available on some securities.
The core difference – the expiration date – creates a variety of consequences.
Let’s break down how this impacts various aspects of trading.
Time Decay (Theta)
Time decay, represented by the Greek letter Theta, is the erosion of an option’s value as it approaches expiration.
Think of it like an ice cube melting on a hot day.
Short-Term Options
Time decay is a major factor.
It’s aggressive and accelerates as expiration nears.
For option buyers, theta is the enemy, constantly working against you.
For option sellers, theta is their friend, generating income as the option loses value.
LEAPS
Time decay is much slower and less impactful, particularly in the early stages of the contract.
Because you have so much time, the daily erosion is relatively small.
This gives you more breathing room to be “right” about the underlying asset’s direction.
Intrinsic Value vs. Extrinsic Value
An option’s premium is composed of two parts:
Intrinsic Value
The amount the option is “in the money.”
For a call option, this is the difference between the underlying asset’s price and the strike price (if the asset price is above the strike price).
For a put option, it’s the difference between the strike price and the asset price (if the asset price is below the strike price).
If an option is not in the money, it has zero intrinsic value.
Extrinsic Value
This is the “time value” of the option – the portion of the premium that’s not intrinsic value.
It reflects the potential for the option to become profitable before expiration.
Factors like time remaining and volatility influence extrinsic value.
Short-Term Options
A larger proportion of the premium is typically extrinsic value, especially for options that are out-of-the-money (OTM) or at-the-money (ATM).
This is because their value is primarily derived from the potential for a quick move in the underlying asset.
LEAPS
LEAPS will have a higher total premium, reflecting a longer amount of time for them to potentially become profitable, a larger extrinsic component.
If the LEAP is deep in the money, then the intrinsic value will be a high proportion of the value.
Volatility (Vega)
Volatility, represented by the Greek letter Vega, measures how much an option’s price changes in response to changes in the underlying asset’s volatility.
Higher volatility generally means higher option premiums, as there’s a greater chance of large price swings.
Short-Term Options
Volatility is a significant factor.
A sudden spike in volatility can dramatically increase the value of short-term options, benefiting buyers.
Conversely, a drop in volatility (“vol crush”) can crush the value, hurting buyers and benefiting sellers (especially after events like earnings announcements).
LEAPS
Volatility is still a factor, but its impact is less pronounced compared to short-term options.
Because LEAPS have a longer time horizon, short-term volatility fluctuations are somewhat smoothed out.
They are more sensitive to long-term changes in implied volatility.
Leverage
Options provide leverage, meaning you can control a larger amount of the underlying asset with a smaller amount of capital (the premium).
Short-Term Options
Offer higher leverage. Because the premiums are lower, you can control the same number of shares with less capital.
This magnifies both potential gains and potential losses.
It’s like using a magnifying glass – it can make things appear much bigger, both good and bad.
LEAPS
Offer lower leverage compared to short-term options, due to the higher premium.
However, they still provide leverage compared to buying the underlying asset outright.
Cost
Short-Term Options
Lower initial cost (premium).
This makes them attractive to traders with smaller accounts or those looking to take highly leveraged positions.
LEAPS
Higher initial cost.
You’re paying for that extra time, so the premium will be significantly higher than a comparable short-term option.
Strategic Applications: When to Use Which
Now that we’ve covered the key differences, let’s talk strategy.
The best choice depends on your market outlook, risk tolerance, and investment goals.
LEAPS: Strategies and Advantages
Long-Term Bullish/Bearish Bets
If you have a strong conviction about the long-term direction of an asset, LEAPS allow you to express that view without the constant pressure of time decay.
Stock Replacement Strategy
Instead of buying 100 shares of a stock, you could buy a deep-in-the-money LEAPS call option.
This gives you similar upside exposure with less capital outlay.
However, you don’t receive dividends with options, and you could lose the entire premium if the stock price drops significantly.
Diagonal Spreads
This involves buying a LEAPS call (or put) and selling shorter-term calls (or puts) against it.
This strategy can generate income while maintaining a long-term directional bias.
Lower Stress
LEAPS can be less stressful than short-term options because you’re not constantly battling the clock.
You have time for your investment thesis to play out.
Short-Term Options: Strategies and Advantages
Income Generation (Selling Options)
Short-term options are popular for strategies like covered calls and cash-secured puts, where you sell options to generate income.
The rapid time decay works in your favor.
Speculation on Short-Term Moves
If you anticipate a quick price movement (e.g., around an earnings announcement or a news event), short-term options offer high leverage to capitalize on that move.
This is high-risk, high-reward.
Hedging
Short-term options can be used to hedge a portfolio against short-term market declines.
For example, buying short-term puts can provide downside protection.
Lower Capital Requirements
The lower premiums make them accessible to traders with limited capital.
Risk Considerations: The Flip Side of the Coin
Both LEAPS and short-term options have risks.
LEAPS Risks
Higher Premium Cost
You’re paying a significant premium for the extended time.
If the underlying asset doesn’t move as you expect, you could lose the entire premium.
Opportunity Cost
The capital tied up in a LEAPS contract could potentially be used for other investments.
Long-Term Uncertainty
A lot can happen in a year or more.
Unexpected events can happen no matter how well-researched an investment thesis is.
Short-Term Options Risks
Rapid Time Decay
The clock is constantly ticking.
If the underlying asset doesn’t move quickly in your favor, the option can expire worthless.
High Volatility Sensitivity
Volatility swings can drastically impact short-term option prices, leading to significant gains or losses.
Higher Leverage, Higher Risk
The magnified gains also mean magnified losses.
Small price movements against you can lead to substantial losses.
Assignment Risk (for sellers)
If you sell options, there’s a risk of assignment, meaning you may be obligated to buy or sell the underlying asset at the strike price.
Conclusion
The “better” choice between LEAPS and short-term options depends entirely on your individual circumstances.
Consider LEAPS if:
- You have a long-term investment horizon.
- You have a strong directional bias on an underlying asset. (Of course, LEAPS can also be used for non-directional and semi-directional trade structures.)
- You want less exposure to time decay.
- You’re comfortable with a higher initial capital outlay.
- You are comfortable with potentially not receiving dividends that a normal stockholder would.
Consider Short-Term Options if:
- You have a short-term trading horizon. Best for day traders.
- You’re comfortable with higher risk and volatility.
- You’re looking for income generation strategies (selling options).
- You have limited capital or want to maximize leverage.
Ultimately, the best approach is to thoroughly understand the characteristics of both LEAPS and short-term options, assess your own risk tolerance and investment goals, and choose the strategy that aligns with your overall financial plan.
Do your homework, start small, and never invest more than you can afford to lose.
Options trading can be rewarding, but it requires discipline, knowledge, and a healthy respect for risk.