Taking The LEAP Into Stock Options

Reserving the right to purchase stock later offers both risk and reward. Here's how to carefully get a handle on it all.

buy or sell a certain number of shares of a certain stock between now and a specific time in the future. A “call,” as it’s labeled in the industry, is a contract to buy; a “put” is an arrangement to sell. You’re allowed a specified amount of time for each contract up until an “expiration date.” Afterwards, the option is useless and has no value. And finally, the amount the contract says you will spend on a stock or receive when you sell it is called a “strike price.”

LEAPs, the variety of option we’ll concentrate on here, normally carry an expiration date about two years into the future. Each LEAP contract covers 100 shares of stock. And, like shares, LEAPs vary in price from company to company. Open up the Wall Street Journal and you’ll find a listing of some of the more actively traded LEAPs. You’ll also notice that for the most part the universe of LEAP contracts is limited to the largest companies–the Exxons, IBMs, Intels and General Electrics of the market.

How are options traded? As a rule, you can place orders for calls or puts with a broker. You’ll have to ante up for a commission, just as you would whenever you buy or sell a stock. A word of caution, though: option commissions tend to be much higher than those for stocks. At some of the larger, full-service brokerages, they run $50-$60 a transaction. At a discount brokerage like Charles Schwab, the commission fee tends to be smaller–in the $30-$40 range. By comparison, stock commissions might run as much as 30% less.

Let’s translate all that into real terms. You see that Intel shares are trading in the low $70s. And although a lot of what you’ve read and heard seems to indicate that the stock might not be headed higher this year, most everyone agrees that the semiconductor maker’s business is still sound. Rather than buy Intel shares with the hope that all this comes true, you opt for an Intel LEAP, a call option for 100 shares with a strike price of $75 that as of April 16 of this year was selling for $10.25. That means that you’d spend $10.25 times 100 shares or $1,025 plus a broker’s commission, say $50.

That outlay of $1,075 gives you the right, but not the obligation, to buy 100 shares of Intel
for $7,500 by an expiration date, in this case January 30, 1999. And once you exercise the option, say a year and a half from now, you’ll ante up the $7,500 for the Intel shares and a commission, we’ll say $35, as you would for any routine purchase of stock. A quick recap: you’ve bought 100 Intel shares for $7,500, and spent $1,075 for the option that reserved you the right to do so, in addition to the stockbroker’s commission.

That’s dandy, but just what benefit is this to you? That depends on the market and just how Intel fares between now and January 1999. If Intel

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