Monday, March 24, 2008

Why buy Leaps

Buying a leap is a very effective long term strategy. It will help you leverage your money in the market. Because of this buying a leap can produce a much greater gains than just buying the stock.

Let us look at an example of how it works. We find that stock ABC is currently trading at $50. It is a strong stock and we believe it will go up. So we buy the stock for $50.

Now we wait as the stock slowly but steadily goes up. Finally after 2 years the stock is now trading at $100. Which means we just made a 100% increase on our money in 2 years. That is good, the only thing is I am sure you could have made more money if you leveraged it.

Let’s see, options are the way to leverage your money in the stock market. If you pay $3 buy the right to buy a stock at $50 then the stock shoots up to $100 you just made $50 from that $3. I don’t even know how big of a return that was, it was huge.

But an average option expires within 1-3 months. The odd of a stock shooting from $50-$100 in a couple months is pretty darn slim. You would want leverage with a little bit more time.

How about trading with a leap. Leaps are simply an option on steroids. It has a lot more time before it expires (usually about 1 to 2 years). Now we can buy the right to buy stock XYZ at $50 within 2 years. We pay a little more for more time, maybe $15.

Since we bought more time we can afford to wait a while for the stock to make a move up. We are not in a big rush. We just let the stock do what it does.

After 2 years stock XYZ is now worth $100. We can buy it at $50 and sell it at $100. Off of that $15 we made $50. This gives us a 333% return on our money. This gives us an edge over buying the stock which would have given us only a 100% return.

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