Wednesday, July 2, 2008

Leaps vs Options

Leaps and options are the two best ways to gain leverage in the stock market. They each have their own advantages and disadvantages.

An option will give you a way to make huge returns on your money in the short term. They will give you a month or two to let the stock do something. If it does the returns will be greater than the returns that you will get from either a stock or a leap.

The problem is that if the stock doesn’t move in that time frame you can also lose more money than if you had either the stock or the leap. Options can also lose money if the stock does nothing. That happens because as the option gets closer to expiring the value of the option will decrease unless the stock moves enough to compensate for the loss.

Leaps on the other hand are just like options. The only difference is that they do not expire for years. That way if you are wrong you do not lose as much in the short term. You also can choose to hold onto the position for a much longer time frame if you believe that everything still looks good.

There are two drawbacks to that. The first is that if the stock does make a big move right away then you will make less money from the leap then you would have if you had just bought the option. The 2nd drawback is that you might hold onto a losing position longer just because you can. Many times it can be better to get out of a trade as soon as it goes against you rather then ride it all the way down. If you have a larger timeframe then you can hold a bad trade and lose more money than you would have if you did an option.

In other words both options and leaps have advantages and disadvantages. You should use your time frame to decide which one is right for you or if one is right for you.

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