Geldpress

If you have been successful with covered calls, then you you may also want to study up on calendar spreads. A calendar spread is essentially a covered call on steroids, and can be used when you expect a sideways or gradually moving market. But managed correctly, it can also benefit greatly from the trader that can effectively adjust from LEAP to calendar spread and back again.

Let’s start with the LEAP, which stands for long term equity anticipation securities. They are structured similarly to standard equity options, but have longer expiration periods. LEAP’s have January expirations and are currently available in many equities and indexes with a January 2009 or a January 2010 expiration. The extrinsic value (time premium) of a LEAP is going to be much greater then a front month option. But overall LEAPs will be much less expensive then purchasing a security or index outright. LEAPs are also less volatile then front month options due the extra time involved.

A buyer of a LEAP call option believes in the long term appreciation of the underlying security. But let’s examine a scenario that maximizes the return of a LEAP by taking advantage of front month price action and volatility.

The hypothetical ABC company sells computers, music players and cell phones. They currently trade for $157 per share. 100 shares of ABC would cost $15,700 out of pocket, but the January 2010 LEAP in ABC, at strike 150, goes for only $41 ($4,100 per contract). The breakeven point of this particular LEAP option is the strike price plus the option price or $191. The ABC company needs to get to $191 per share in January of 2010 just to break even. It needs to move over $191 to make a profit.

Assume that an investor buys a 2010 strike 150 LEAP in the ABC company on July 29, 2008 at a time when the ABC stock sells for $157. Option pricing is not an exact science, but suppose the ABC shares rally to $167 on July 27. The Jan 2010 150 LEAP contract may also move from $4,100 to $4,900 at the same time, for a healthy 19.5% gain on investment. But using the LEAP as a cover, the trader could then sell a front month option in ABC to potentially increase that profit. The August front month 170 call option might go for $4 ($400 per contract) with ABC just shy of 170. If ABC hits August expiration at under 170, then the August 170 call expires worthless, leaving the entire $400 premium collected as additional profit. But even if ABC nears August expiration slightly above 170, the front month August option could still be bought back (BUY TO CLOSE) for potentially less then you sold it for. In that case, you profit from the rally in the LEAP, plus the additional profit gained from the front month August contract. When you close out the August front month contract - either buying it back or letting it expire worthless - you have effectively gone from LEAP to calendar spread and back to LEAP again.

For additional reading, please CLICK, BUY and READ:

Disclaimer:  Investing and/or trading is dangerous and you can lose money.