The Virtues of Long-Dated Call Options
Long-dated call options have expiration dates far in the future. In the financial world, these options are referred to as LEAPS. which is an acronym for “long-term equity anticipation securities”. Any option with an expiration date one to three years in the future is considered a long-dated option. Such options offer attractive characteristics for investors.
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Cost
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Buying long-dated calls is similar to buying stock outright in many respects. However, there is an important difference in that buying call options costs less than buying stock. Therefore, the option investor may gain the same market exposure as the stock investor while investing less initial capital.
For example, as of September 2011 it is possible to purchase long-term options on stocks such as Apple (AAPL) and Amazon (AMZN) for less than 20 percent of the cost of buying the stocks outright. This lower cost is possible because call options do not convey stock ownership, but rather give the option holder the right to purchase the stock at a set price. The other key difference is that options eventually expire, while stocks do not.
Spreading Potential
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When an investor holds a long-dated call, he may choose to sell covered calls to increase his return on the position. This kind of trade is referred to as a horizontal or calendar spread. For example, if an investor holds a long-dated call on XYZ and market activity is flat, he may sell a near-term call on XYZ. If the market remains flat through the life of the near-term call, the investor earns money from the sale of that option and still retains his long call position.
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Slow Time Decay
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The time value is the portion of an option’s value that constantly decreases over time. This value is a component of all options that becomes increasingly relevant as an option nears expiration. Time value does not decrease at a constant rate, but instead decreases slowly at first and then at a higher rate toward the end of an option’s life. For this reason, time decay is less of a concern for holders of long-dated call options as opposed to holders of short-term options.
Versatility
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If a long-term option position becomes profitable, the investor holding the position has flexibility in making his next trading decision. One choice is to close out the position by selling an offsetting call option. In this scenario, the investor captures a profit and exits the market. Alternatively, the investor may exercise the call option and buy the underlying stock at a discount to the current market price. The specific price at which the investor may buy the stock is identified by the option strike price.
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