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.

rises a considerable amount, say from a current price of $75 to $200 a share, you’ll spend $7,500 plus commissions to buy Intel shares now worth $20,000, netting a profit of about $11,390, or 76%, a healthy sum if you exercise your right to buy under a call contract.
If instead Intel falls to $50, your option would expire worthless, a waste of $1,075. But look at it this way: that’s a loss far less than the $2,500 you’d be out if you had purchased 100 shares of Intel at $7,500 and then seen your investment slip to $5,000.

That’s the most conservative route to take. Bear in mind, too, that the option itself holds a certain value, one that rises and falls according to what the stock it’s tied to is doing. And once the stock your option contract covers rises above the strike price, it’s possible to make a very large sum of money.

Here’s an example of a LEAP investment Hamilton Lewis set up for his client Arthur Strahan, a former defensive end for the Houston Oilers turned cement sales executive. Strahan, who holds a six-figure account with Lewis, has more than enough cushion to cover the risks of option investing. So earlier this year, Lewis noticed what he thought was a good deal in Microsoft LEAPs. While Microsoft shares were fetching $75 at the time, Lewis found their LEAPs, expiring in January 1999 with a strike price of $80, were selling for $10 each. That meant that a bet that Microsoft would rise $5 in a little under two years was priced at $1,000. Lewis bought five contracts for Strahan at $5,000. Three weeks later, when Microsoft shares rose to $99, Lewis saw the LEAPs had increased in value to $16.50, or $1,650 for each contract. He sold Strahan’s entire holding at $8,225, bagging his client a 65% profit. “I have to tell you, it’s good to work with someone who knows the market like he does,” says Strahan.

CARRIED AWAY
Part of the risk of option trading is the simple fact that it’s easy to get carried away simply because a little sum of money seems to go a long way. As of this writing, the right to buy 100 shares of Coca Cola at $90 a share in January 2000 costs $3,250. But be wary, say options traders. If Coca Cola stock doesn’t reach $90 at any time, you stand to lose your entire investment. If you’ve bought one LEAP at $3,250 in addition to $50 in commissions, that’s $3,300 down the drain.

“Buying, say, $10,000 in LEAP calls is nowhere near the same as putting $10,000 into the company’s stock,” says Seeley. “Approach it that way, and you’re taking an extraordinary amount of risk…you could destroy yourself.”

“My advice is to merely buy LEAPs to cover the exact number of shares you’re able to purchase,” says Lewis. “It may sound like an oxymoron, but if you’re busy trying to make money, you should make sure you don’t go broke

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