When most individual investors use options trading information, they think of short-term bets, options trading articles tell us. But options can be just as effectively used by the longer-term investors to gain leverage that simply going long a stock does not afford. In other words, you can be an investor, not a trader, using options.
For example, let’s say you like Apple Inc. (NASDAQ: AAPL) at $270, and want some leverage (not to mention, you may not want to pay that much for shares). My advice would be to by deep-in-the-money 2012 LEAPS.
LEAPS stands for Long-Term Equity Anticipation Securities, and refers to options with expirations that are further than one year out. And you can use these options to go long, as well as short.
If you believe the Lipitor patent expiration will really hurt Pfizer Inc. (NYSE: PFE) (it will), and that the Street is not fully pricing this into the stock price (it is not), then you can short the stock by buying deep-in-the-money 2012 puts (an open position in my Short Side Trader service) to play the stock’s long-term troubles.
So, what should you look for when you want to invest or go short long term?
1. Find a great story.
Make believe you are actually investing. Apple selling one iPad every two seconds, or Pfizer facing a Lipitor patent expiration without a replacement product are two good long-term stories.
Also, use your imagination and look at ETFs, too. For example, if you want to play the euro story, you can buy LEAPS on an ETF like the CurrencyShares Euro Trust (NYSE: FXE). (See also, 3 Ways to Profit From the Euro Zone Crisis.)
2. Use long-term LEAPS.
Yes, LEAPS are already long-term options, but I mean buying ones that expire in 2012 or 2013 as opposed to 2011.
3. Buy deep-in-the-money options.
Look for LEAPS with a fairly wide range of strike prices and go for ones that are deep in the money.
4. Choose LEAPS that are liquid.
Make sure there are at least 1,500 open contracts for that expiration date, and at least 500 open contracts for that strike price.
5. Use stop losses.
With LEAPS you should be prepared for volatility that is higher than you get with a stock, but less than with a shorter-term option, and then manage your stop losses accordingly.
6. Manage your position.
Even though expiration is a long way off, you should actively manage you position based on the stock price and whether the underlying story of the company in question is playing out as you’d hoped. This position should change over time depending on fluctuations in the stock price. “Roll” the LEAPS from one strike price to another as the initial position gains in value. Or, if it moves against you, consider selling the first position at a loss and moving to another strike price with more leverage.
7. Set target prices for the stock and the LEAPS.
When you hit your targets, don’t just think about selling, get out.
If trading LEAPS with an investing mindset is an approach that appeals to you, start slowly and only use your speculative money, i.e., money you can afford to lose. Longer-term options are carry less risk than short-term options, but they are still options.
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