LEAPs¶
Long-Term Equity Anticipation Securities - options with expiration dates more than one year out.
Resources¶
Stock Replacement Strategy with LEAPs¶
The Stock Replacement Strategy involves buying a high-delta, deep in-the-money (ITM) call LEAP instead of 100 shares of stock. Since the call is deep ITM and implied volatility is reasonable, you'll pay minimal time premium—potentially even less if there's a dividend.
Advantages¶
| Advantage | Description |
|---|---|
| Minimal Time Decay | LEAPs experience very little theta for many months, resulting in low daily cost of ownership |
| Reduced Catastrophic Risk | At expiration, a call LEAP has less risk than shares. If price drops below stock price minus LEAP cost, the shareholder keeps losing, while call owner cannot lose more than initial cost |
| Lower Pre-Expiration Risk | LEAPs may lose less than stocks due to decreasing delta as price drops |
| Rolling Up | If underlying rises, you can roll your call up, taking cash off the table and reducing risk |
Disadvantages¶
| Disadvantage | Description |
|---|---|
| Time Premium | Some time premium is paid, even with deep ITM LEAPs |
| Bid/Ask Spread | LEAPs often have wide bid/ask spreads, making adjustments costly |
| Dividends | Share owners receive dividends; call LEAP holders do not |
| Cost After Drop | If underlying drops significantly, IV may rise, making new LEAPs more expensive |
Rolling Strategy
If you still like the stock's upside, consider rolling your LEAPs before they become traditional options, to avoid accelerating theta decay.
Deep OTM LEAPs: Are They Mispriced?¶
The Hypothesis
Query: Are way OTM LEAP puts (200%+ down) and way OTM LEAP calls (100-200%+ up) systematically mispriced by market makers in your favor?
The Verdict: NO
The weight of both "fintwit"/trader commentary and academic/quant work points to the opposite:
- Deep OTM index puts are usually overpriced (bad to buy, good to sell) as crash insurance
- Deep OTM "lottery" calls are also generally overpriced because people overpay for lottery-like payoffs
- Long-dated options (LEAPS) can be mispriced at times, but there is no expert consensus that way OTM 2-year options are systematically underpriced
1. Academic/Quant Research on Far OTM Options¶
| Finding | Source |
|---|---|
| Selling OTM puts and calls has historically earned positive returns for the seller, meaning buyers have negative expected return | AQR (Ilmanen) |
| OTM index puts are structurally expensive - implied vol is much higher for far OTM strikes (volatility smile/skew) | Post-1987 studies |
| Deep OTM options are often overpriced due to volatility smile, making them less effective as tail-risk hedges | LEAPS mispricing reviews |
Key Implication
On average, across many markets and years, deep OTM options have tended to be bad bets for buyers, not hidden bargains.
2. Taleb / Barbell Arguments and Critics¶
The Taleb View¶
- Very small-probability, large-payoff events are underrepresented in historical data, so models underprice extreme tail options
- Advocates a barbell: most capital in safe assets, a small slice in long OTM options as "moonshots"
The Counter-Arguments¶
Ilmanen on Taleb
Taleb likes OTM options; "virtually all the literature" finds OTM index puts relatively expensive and with very negative long-run returns.
- Taleb's 1980s tail-hedge success was in a very different regime
- Now "options pricing models have changed to make far-out-the-money options more expensive"
- Blind OTM-buying is "just buying lottery tickets with no edge"
Conclusion
There is a philosophical/risk-management argument (don't be short catastrophic tails) but not a strong empirical consensus that those options are cheap. Even Taleb fans suggest very small size (1-3% of assets) in long OTM protection.
3. Practitioner Views on Deep OTM LEAPs¶
Deep OTM LEAP Calls ("Lottery Tickets")¶
| Observation | Source |
|---|---|
| "Deep out of the money options are essentially lottery tickets" | Hacker News |
| Rare huge wins (30x+) documented, but these are lottery-like outcomes, not reliable edge | SteadyOptions |
| Deep OTM LEAPs are "extremely high risk, high reward" and will often expire worthless | r/options |
| OTM LEAPs should be sized like "money I'm comfortable gambling with" | r/options |
Deep OTM LEAP Puts (Crash Protection)¶
| Observation | Source |
|---|---|
| Price to protect with far-dated OTM puts "has ballooned" post-pandemic | Practitioners |
| "Post-pandemic, the market is charging much more for the same protection" | Option Alpha |
| Deep OTM options are often overpriced due to volatility smile | LEAPS research |
For Bearish Plays
Expert commentary suggests 200%-down LEAP puts tend to be expensive insurance, not cheap. Short-term directional plays via long-dated, way-OTM options are usually discouraged.
4. Are Long-Dated Options More Mispriced?¶
What's True¶
- Long-dated options are more prone to pricing errors due to uncertainty in rates, vol regimes, and model assumptions
- Hull & White (1994): Black-Scholes can produce up to 20% pricing error on long-dated options
- LEAPS are often less liquid, creating bid-ask spread deviations from model value
What's Also True¶
The Catch
- Professional market makers specifically arbitrage obvious LEAP mispricings
- Any persistent, easy edge tends to be competed away
- Where mispricings linger, they might just as easily be overpricing (bad for buyers) as underpricing
5. Retail & Fintwit Sentiment¶
| Common View | Details |
|---|---|
| "Unconventional" | Maximum loss is 100% of premium |
| Liquidity risk | Major issues with deep OTM and far-dated options |
| Vol sensitivity | Cheap premium = large bet on implied volatility changes |
| Speculative only | Viable only with small allocations and high conviction |
Bottom Line
Fintwit-style wisdom frames these trades as lottery/speculative plays, not a robust systematic edge versus market makers.
6. Where This Idea Works vs Breaks¶
âś… What's Right in the Intuition¶
| Point | Explanation |
|---|---|
| Models are imperfect | Long-dated, far OTM options exist where Black-Scholes extrapolates heavily |
| Vol regimes are hard to model | If you have an edge in forecasting regime shifts, LEAPs can express that edge |
| Asymmetric payoff is useful | Small slice for tail hedges can make sense in a barbell portfolio |
❌ Where Evidence Contradicts¶
| Point | Explanation |
|---|---|
| Buyer generally loses | Options are priced with risk premium that compensates the seller |
| Tails repriced upward | Post-1987 and especially post-COVID, markets charge more for tail protection |
| "Gambling" consensus | Pro traders describe buying deep OTM LEAPs as lottery tickets with no inherent edge |
7. Practical Takeaways¶
If you still want to explore this strategy:
Best Practices
- Treat as small, barbell-style bets - 1-3% of portfolio premium per year, not core exposure
- Prefer liquid underlyings - Index options or very liquid single names to avoid spread crush
- Focus on thesis-driven situations - Crisis lows, extreme IV cheapness, obvious structural change
- Measure realized vs implied vol - If implied vol in tails consistently above realized, they're expensive
- Align maturity with thesis - If "short-term bearish," short-dated puts offer more direct exposure than 2-year 200%-down puts
Bottom Line on Deep OTM LEAPs¶
No Systematic Edge
There is no strong evidence or expert consensus that:
- Way OTM LEAP puts (e.g., 200% down) or
- Way OTM LEAP calls (e.g., 100-200% up)
are systematically underpriced by market makers in a way that makes them a broadly "good" strategy.
The Reality
Tail options, especially long-dated and far OTM, tend to be expensive insurance/lottery tickets, not easy edges.
A small, thesis-driven or barbell-style deployment can make sense, but it should be viewed as speculative or portfolio-insurance spending, not a mispricing arbitrage.