Transcription
Hey everybody, welcome in. Today, we're going to talk about my favorite strategy of all, and that is LEAPS. They are options, long-term options, and we're going to talk about everything about them. Some example cases of how I can make $9,000 on trades using LEAPS, and why I love them, things to watch for, how to trade, and how to find really good opportunities. So, this is going to be, as usual, heavy numbers, but you know, if you want to learn how to make really good money, this is how.
So, uh, let's just jump right in. As usual, it's almost becoming a cliché. So, LEAPS, my favorite option strategy. Of course, as always, none of this is investment advice. This is for entertainment purposes only, and that's kind of what I like to do. So, uh, this is again, heavy math. Math is the future of money. You know, guys, how much I love Bitcoin, which is pure mathematics. And I'm really happy that so many of you are really interested in the stuff that I do. I've just blown through 1.2 million views of my videos, which just started in December, which is mad. And thank you for all the new subscribers. I didn't think people would actually enjoy the stuff so much. So, really blown away, and I continue to keep pushing out really top-notch quality every day that's unique on the internet.
So, let's talk about LEAPS real quick. Uh, they, the definition of LEAPS is Long-Term Equity Anticipation Securities. It is a bit of a cheesy acronym, but that's what it is. LEAPS, and the such thing is a LEAP. Some people prefer to leap singular, but it's actually LEAPS. So, enough of that, you know what I mean if I do say leap by accident.
So, what are the advantages of LEAPS? So, I sum it up in four basic categories. One, you've got time. A lot of time. LEAPS tend to vary between one and three years in duration, and that gives you stability. It gives you leverage, great leverage, and I'll talk more about the math of that. And with leverage comes great returns when you back a winner. Remember, if you invest in an option in a company like, say, ExxonMobil or a GE or a, I don't know, some crappy company, Berkshire Hathaway, you're not going to do well. You've got to be able to position a LEAP on a winning stock, and then you can do very well. And I'll talk to you about how you can find those as well.
So, LEAPS defined. LEAPS are publicly traded options with expiration dates normally greater than one year out, up to three years from the date of issuance. They are identical to other options, but just longer times until expiration. And they're typically traded on well-traded stocks, ETFs, and indices. So, you could actually use LEAPS if you're bullish on the S&P 500 or some ETF like an ARK ETF. You can actually buy LEAPS on those.
So, when I talk about short-term calls versus LEAPS, the easy way in my mind to think about it is think of rent per month, i.e., time value. So, short-term calls are like renting a five-star hotel room at a thousand dollars a night. And the LEAP is like buying a house and paying two and a half percent mortgage interest. So, actually, right now, today, believe it or not, you can borrow on a 10-year fixed, 30-year fixed in some cases, half a million dollars or a million dollars at two and a half percent. So, a thousand dollars a night in a hotel is the same as paying interest only for a half a million dollar mortgage. Think about that, a thousand bucks for a half a million dollar mortgage. But that'll come later, more on some of my real estate stuff that I'll be talking about soon. So, just remember, where would you like to blow your money? Do you want to be in the thousand dollar a night place, or do you want to spread your cost of your option out over time? And, uh, I just wanted to try and give something that you guys can all wrap your heads around.
So, let's look at a little bit of the math. And I'm sorry to jump straight into this, but it's very important. And I believe it's easier to illustrate things with examples. This is a real-life example, and it's one of the examples of the LEAPS that I did. And I've been investing in LEAPS since the '90s. Historically, I went out and bought a Tesla X in the beginning of 2019. And I was so blown away by the car that within a couple of days, I went and looked at the call options and I immediately bought some contracts of the 200 calls in 2019. The expiration of these calls was January 2021, which just passed. And Tesla at the time, the stock was trading about 190. The cost of each option was 45 times 100, so it's $4,500 a contract. Remember, when we are talking about an options contract, it controls 100 shares. So, you see the price is $45, you've got to multiply that by 100 to get the total price of the actual contract. So, and the cost of equity at the time to buy 100 shares was $19,000.
Now, what happened? What made it really interesting, and the real power of the LEAP, is Tesla jumped from $190 bucks to $1,400. It split five for one. So, now you have five contracts. If you buy one contract and the stock splits five for one, you get five contracts. Make sure everybody gets that. So, if you are getting into a two-year LEAP, and that equity actually splits, the number of your contracts actually goes up by the split amount. And I did the same thing with NuScale Power and a whole bunch of others. So, I was very fortunate to be in equities that actually split. So, it's very good to try and anticipate when that happens because if there is a split announcement, the first thing that pops is the LEAP prices as well, because investors like me know they become more valuable.
Let's go a little bit deeper. I now have five contracts for every one contract that I had before, and the strike is now $40. It's not $200. So, you divide the $200 strike by five, you get $40 bucks. Cost per contract now was $900 at a $40 strike. It's no longer $4,500 a contract. Hope you guys are tracking with that. And then, post-split, Tesla goes up again, another rampage of $850. And that is the point in which I shorted it. I sold out-of-money calls against my long position, but that's a separate story. I'm not going to get into that today.
So, if you do the math on the right-hand side, you'll see exactly what happened. Basically, the return on the option is 9,000% rounding up from 8,900%. And the return on equity is about 2,000%. So, you can get four to five X the return you will get over holding the equity with a LEAP option. That's one of the reasons why I'm so fascinated by them and I love them so much is because of that leverage. But I'm going to talk more about that in a minute as well as we go further.
So, there's some terminology you all need to know and be aware of, and it's going to walk you through it real quick because you'll hear me, like on Patreon, use these terms all the time. And, uh, just make sure you know what they are. So, a call is in the money (ITM) if the market price is above the strike price. And a put option is in the money if the market price is below the strike price. Very important to understand call and put, the difference. And an option can also be out of the money (OTM) or at the money (ATM), not an ATM machine, but at the money. And it's always important when you're buying LEAPS to buy in the money, unless you're extremely bullish. You can buy out of the money if you expect a big move.
Now, the other thing that we've got to go to, unfortunately, is the Greeks. And I'm just going to really focus on two of them today. And in subsequent videos, I'll go deeper into the other ones. But the two that I really want you guys to understand is the Delta, which is the sensitivity of a price to changes in value of the underlying security, and Theta, the rate of time decay of an option. These are the two that I love to analyze and love to play, and I'll show you why.
So, here to go into the Greeks with an actual case. This is a trade I actually posted on Patreon. This is Illumina. I actually hold Illumina, and I bought the 300 LEAPS for $90. So, that gives me the right to buy Illumina in January 2022 for $300. The cost was $90. So, my break-even point is $390. If Illumina falls below $390 before expiration, I start to lose money. Now, the Delta on the position, you can see I have highlighted there, is 0.88. So, basically, for every dollar Illumina goes up in value, I make $88 for every contract that I have. Now, what's also important is this is time decay. This is the Theta. So, what you see there as well, the time decay that I have in this position is about $8 a day for the entire position per contract. So, make sure you understand that as well. So, if the, if Illumina goes up a dollar, I make $88. And every day, the time decay is $8 because no matter what. And that's part of the beauty and the danger of options, because that time decay disappears. Just in summary, the two Greeks that we looked at were Delta and Theta. The rest we'll talk about later.
Now, these are the LEAPS rules and things you all need to watch for when you play. And again, I'll bring in some more examples. First of all, when do you buy? So, if you think about buying LEAPS, you want to do so when implied volatility is relatively low. That's called the Vega. And you sell options when the Vega is high. Think of volatility. You've heard me talk about VIX, Vega, VIX, volatility. I think beginning with V typically is volatility. That means the price is fluctuating a lot. And when that happens, the price of the options is high. And I love selling options when the volatility is high. And that's exactly what I did with the Illumina as well, but we'll talk about that in a separate video. And then Rho is the option sensitivity to changes in interest rates. But because we are in basically a zero interest rate environment, it doesn't matter. So, we won't actually look at that at all.
So, long-term outlook. When you are picking something to buy a LEAP on, you need to pick something that you're very bullish on. You need to find the bottoms, and you need to identify the range. And again, I do some of this in my technical analysis stuff with the Patreon members. But this is an example of a chart where you would look. You would find a range, look at a multi-year trend, and you would identify when bottoms are, which identify good entry points. And then you jump in from there. And then after that, it's very important to make your thesis. For example, your thesis could be Tesla having a $1 trillion market cap, or Apple going to a $3 trillion market cap. That's a better example. So, the Apple market cap currently is $2.115 trillion. What would the stock price be if it goes to $3 trillion? And then you look at your options and you map that back, you reverse back into where you need to be to be able to identify what strike you want to buy and how much you expect to return from it. Because again, you're always paying for time, and time is expensive.
The other thing as well, you've got to consider is stock options are always risky. And if you do not know what you're doing, you will get wrecked. You will lose your money. So, it's very important when you structure your investments with LEAPS, you've got to be very bullish on the stock. You don't want to pick a stock that could be flat for one or two years, or a stock that could go down. You get toasted. You need to pick something that is extremely bullish, extremely disruptive, a leader in the space. And a rise of 50% of the stock price could easily be a 300% gain, very easily. And if you are really going to pick in the right option, you can do a lot more, like my Tesla $9,000 return.
The other thing to watch for as well is you need to make sure it's open interest and good volume in the actual option. This is the Trading Desk, another one I have a position in. And you can see if you look way, way out, the 41440 call for January 2023, only two of those contracts are traded today, and they're quite expensive. So, you want to make sure that you pick options that are well-traded, not only so you can buy, but also so you can sell down the line too.
Limit orders. You should always use limit orders when you're buying these options because there's always going to be a very big spread between the bid and the ask. And for those that need a quicker reminder, the bid is the price a buyer is willing to pay for a stock or an option. And the ask is the price a seller is willing to sell their shares or their option for. And remember, when you're in that marketplace, it's you against the machine. So, remember, everything's a zero-sum game. If somebody is selling you an option and you're buying it, you've got to think, why are they selling it? They're selling it because they think they can win and make more money. So, always groom with that mindset as well. Because if you go in thinking, oh, you're just buying it on the marketplace off the shelf, no, there's somebody on the other side of the trade. You need to be able to beat that person or that machine or that hedge fund or whoever it is. So, be very careful and always think in those terms as you go forward.
Another very important thing, and one of the reasons I like LEAPS, is taxes. Now, where I live in California, if I make a gain on a trade that is less than 12 months old, that goes straight to my income. So, I pay more than 50% taxes on any gains, which is not good. So, therefore, I like to have my capital gains be at least 12 months out. So, the key is to hold a LEAP for at least a year and a day to be taxed at the long-term capital gain tax rate. Now, I don't know what country you might be in or what your tax situation is, but that's the story for California. It varies state by state, country by country. So, remember, it's very important as well not to trade like crazy if you are living in a high-tax jurisdiction. Taxes have to be part of every investment thesis as well. A lot of people ignore that.
So, the conclusion, real quick, as always, as a conclusion. So, make sure you stay till the end. How I operate, I make my list of key names. In fact, right now, I'm making my crash list. I'm looking at names that I will get into after the 2021 crash happens, if there is one. And if there isn't, I'll be picking up positions along the way. I will very carefully identify my entry before it even gets to that point, and I set up all my alerts as to when my entries hit. I analyze the option Greeks, and I pick my perfect option depending on the numbers of my analysis to make sure I get the right strike and I pay the right price. And then I sit and wait for the option to present itself, and then I execute like a hunter in the woods. I just wait.
So, again, imagine I'm looking at 30 stocks. I've identified my entry. I know pretty much what type of option positions I want to get into, what the balance is between Delta, Theta, etc. And I know exactly the pricing and the makeup between intrinsic and extrinsic value of the actual option itself. And then I'll wait.
Now, circling back real quick back to the Illumina example. Remember, Delta is key. And with this type of leverage, you control almost 100 shares at 88% of the price. So, this Illumina case, right now, the price of Illumina is $470 a share times the Delta 0.88 is equal to controlling about 414 shares worth of Illumina. So, a quick trick is to look at the Delta, and you can find that in any brokerage platform. It'll show you when you look at the actual option. And you can use it as saying 0.88 times the actual price currently will give you how much shares you control with this actual option, which is a neat trick. And again, when I talk about leverage with these LEAP options, you de facto control the shares as long as they're going up. Once if they tank, you'll lose everything. So, always be aware of that risk as well.
Now, getting back to the trade as well, it's always important to go in with your eyes wide open. Here, you see the Illumina call option. That cost is $9,000, so it's 100 times $90. The break-even point for every contract, the break-even point is $390. The time decay is gradual. You can see the red there at the bottom showing the actual time decay over time. And that's the beauty again of LEAPS is because the time decay is gradual. And if Illumina goes to say $880, your profits are $49,000. So, again, $9,000 can give you $50,000, again, powerful, powerful returns. But remember, there's always risk. And the red stuff in that chart is the risk of loss. So, make sure you go in with your eyes open.
Big thank you to the Patreon community. Love working with you every day. As usual, um, I am putting together my list of targets with potential entry prices. And of course, if I see anything I like after the crash, whenever the crash happens, or if we're already in the middle of it right now, and you know, I've, I turned very bearish over the last couple of weeks, um, I will be posting some of the things that I see as good options right now to buy. And if you like this content, hit the like, subscribe if you haven't already. I appreciate all the support. Everybody, watch for the scammers. I'm active in the comments. What they're doing now is when I make a comment, they're replying to the comment, and they're still tricking people out there. They're dropping phone numbers and asking you to call them. Don't ever call anybody. Thanks, everybody. Take care.