LEAPS and Bounds

I've been trading options occasionally for several years, and it's a tricky market. The small investor is preyed on by a slew of options trading seminars and "educational websites" that teach complicated and (due to commissions) expensive strategies -- with some of the more exotic strategies, like condors and butterflies, you could be trying to yoke four different options together. And anyone who has traded options knows how illiquid they can be compared to equities, making those multi-option trades very difficult to pull off effectively.

In my opinion, LEAPS (Long Term Equity AnticiPation Security) are about the only derivative that I feel worth using. When you first start option trading, the front-month options with their bargain basement prices seem like the way to go -- buy a stack of them ahead of an earnings call and wait for the surprise to make the option pop. In fact, that strategy -- essentially, of buying very out of the money options, letting most expire worthless and occasionally winning big enough to compensate and profit on the few -- is the strategy that a primary proponent of the inability to know anything about the future action of the markets, Nassim Nicholas Taleb, uses in his options trading. It's not necessarily a bad strategy, but one that I find takes an incredibly strong stomach and one that can often see you losing a lot of money and doubting yourself when you haven't made the big score. Sounds like gambling.

With LEAPS, there is still the possibility of losing the entire investment, like in any option that might expire worthless at expiration. But what I like about LEAPS is that you are able to make time more of an ally -- for most equities these days, a year or two is enough to see significant change in market value (unless, and this is quite possible, you choose an underlying stock that remains stagnant -- there's no perfect strategy in investing), and there is a definite exit time for the strategy. Although you won't lose your investment in a stock, it's quite possible that you will see the same loss and yet continue to hold on to that position while you wait for it to return to breakeven. Unless you specifically invested in that stock with the intention to hold it indefinitely, I view that as a bad trait of an active investor -- being anchored to a position when that capital that is locked up can be deployed elsewhere. The freer your capital, the better off you are.