My First LEAP Option Purchase
A LEAP stands for “Long Term Equity Anticipation Security.” It basically is the purchase of a stock option with an expiration period a long ways in the future. Some of the benefits of the LEAPs include a high delta (for in-the-money options) and a very, very small theta.
Johnny could describe these terms much better than I could but here it goes. Delta refers to correlation of change in stock price with change in option price. The more in-the-money the option is, the closer the delta will be to 1, meaning that a $1 change in the stock price would equate to a $1 change in option price.
Theta refers to price decay. Since the LEAP I purchased expires in January 2016, the theta decay each day is very small.
On Thursday, February 6th, 2014 I purchased a one call contract of WPRT January 15, 2016 with a strike price of 15.
One call contract allows me to purchase 100 shares of WPRT at $15/share anytime from now until the expiration date. Westport Innovations is a company that specializes in building and designing alternative fuel and natural gas engines and vehicles. Given the abundance of clean-burning natural gas in the United States, I feel that this technology is on the verge of taking off.
Westport had also, for some reason, taken a huge hit in the past year. On February 6, 2013, it closed at 27.44; on February 6, 2012, it closed at 39.67.
I have confidence in the future of the natural gas industry in the US. Westport is positioned to benefit from this transition.
I was actually considering purchasing $1500 worth of WPRT stock. However, because WPRT does not pay a dividend, I decided that buying the option may be a “safer” and potentially much more profitable trade. It also lets me keep more cash free to buy other things.
Let me explain: By purchasing the option I effectively now control 100 shares of stock currently valued at $16.29. The cost (premium) of doing this was only $460. Because it is currently “in-the-money,” I can execute this trade at anytime (but wouldn’t make sense now…explained below). On the date of purchase of the option, WPRT closed at 16.23. 100 shares (before commissions) would have cost $1623. For that cost, I would have been able to buy 3 contracts (representing 300 shares) (4.60 x 3).
After factoring in the premium that I paid, my break even point is:
15 + 4.60 + 0.0971 = 19.6971
Anything above 19.6971 is profit. I lose everything ($460) if the stock finishes below 15 on expiration. Since it is currently in-the-money, it has inherent value at this point. If it is looking like I might not make too much of a profit, I can always roll the option over to the future or sell for a small loss.
I effectively match the movements of the underlying stock without having as much risk.
To see the power of this strategy, see the table below:
(Assumptions: strike price 15, break even 19.6971, 1 contract)
| Price | Stock P/L | Stock Return | Call P/L | Call Return |
|---|---|---|---|---|
| 0 | -$1623 | -100% | -$460 | -100% |
| 5 | -$1123 | -69.19% | -$460 | -100% |
| 15 | -$123 | -7.58% | -$460 | -100% |
| 20 | $377 | 23.23% | $30.29 | 6.58% |
| 30 | $1377 | 84.84% | $1030.29 | 223.98% |
| 40 | $2377 | 146.46% | $2030.29 | 441.37% |
| 45 | $2877 | 177.26% | $2530.29 | 550.06% |
What you can see from the table is that my maximum loss is $460 with the option but up to $1623 if purchasing the stock directly.
I’m excited to see how my first LEAP purchase performs. While I have not yet updated my portfolio to reflect the option, I will get around to doing that soon.
For more information about LEAPs, you could visit the page here: Using LEAPS Instead of Stock to Generate Huge Returns
Full disclosure: WPRT Call Option
