What Are Long Term Options?
Long term options are a type of derivative contract that grants the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined strike price on or before a specified expiration date in the distant future. These options typically have maturities extending beyond one year, often ranging from nine months to several years, distinguishing them from standard options that usually expire within a few months. Also known as Long-Term Equity AnticiPation Securities (LEAPS), long term options are a strategic tool within options trading that offers investors a longer time horizon to benefit from potential price movements of the underlying security.96, 97, 98
Within the broader category of financial instruments, long term options provide a way to gain exposure to an asset's price fluctuations with potentially less capital outlay than directly owning the asset. The extended timeframe influences their premium and how they are affected by factors like time decay (Theta) and volatility. Investors utilize long term options for various purposes, including speculating on future price appreciation, hedging existing positions, or managing portfolio risk.94, 95
History and Origin
The concept of options dates back to ancient times, with early forms of contracts allowing individuals to secure rights to future transactions. One of the earliest documented examples is attributed to the Greek philosopher Thales of Miletus, around 600 BCE, who reportedly made a profit by securing rights to olive presses based on his prediction of a bountiful harvest.91, 92, 93 Another notable historical instance where options played a significant role was the Tulip Mania in 17th-century Holland, where call options were used to speculate on the skyrocketing prices of tulip bulbs.88, 89, 90 This period highlighted both the potential and the speculative risks associated with such contracts.87
Modern options trading, with standardized contracts and regulated exchanges, began to take shape in the late 19th and early 20th centuries, primarily through over-the-counter (OTC) dealings. However, a major turning point occurred with the establishment of the Chicago Board Options Exchange (CBOE) in 1973.83, 84, 85, 86 The CBOE introduced standardized option contracts with clear rules, pricing mechanisms, and a centralized clearing house, revolutionizing the accessibility and transparency of options trading.80, 81, 82 The introduction of Long-Term Equity AnticiPation Securities (LEAPS) by the CBOE in the 1990s further expanded the options market, providing investors with contracts that offered significantly longer expiration periods.78, 79 This innovation allowed for longer-term strategic planning and reduced the pressure of rapid time decay common in shorter-dated options.76, 77 The CBOE's historical evolution is a testament to the ongoing development and formalization of financial derivatives markets. [Cboe.com/about/history/]
Key Takeaways
- Long term options, or LEAPS, are derivative contracts with expiration dates typically ranging from nine months to several years.74, 75
- They provide investors with a longer timeframe to be correct about the direction of the underlying asset's price, reducing the immediate impact of time decay (Theta).72, 73
- Long term options can offer significant leverage, allowing investors to control a larger position in an underlying asset with a relatively smaller capital outlay compared to buying the shares outright.70, 71
- They are often used for long-term speculative positions or as a hedging tool to protect investment portfolios against potential downturns.68, 69
- While they offer benefits, long term options still carry risks, including the potential for loss of the entire premium if the underlying asset does not move as anticipated before expiration.66, 67
Interpreting Long Term Options
Interpreting long term options involves understanding their unique characteristics compared to short-term options and how market dynamics influence their value. Because long term options have extended maturities, their premiums tend to be higher due to the greater amount of extrinsic value or "time value" embedded in them.64, 65 This extended time allows for more potential for the underlying asset to move favorably, but it also means the option buyer pays more upfront.62, 63
A key aspect of interpreting long term options is their lower sensitivity to daily time decay compared to short-term options.60, 61 While all options lose value as they approach expiration, the rate of time decay (theta) for long term options is initially much slower, increasing significantly only as they get closer to their final 60-90 days before expiry.58, 59 This characteristic makes them more suitable for investors with a longer-term market outlook who want to reduce the pressure of precise timing.57 Furthermore, long term options are still influenced by changes in the volatility of the underlying asset, which can affect their pricing.56
Hypothetical Example
Consider an investor, Sarah, who is bullish on Company X, whose stock is currently trading at $100 per share. Sarah believes that Company X's stock will rise significantly over the next two years due to upcoming product launches and strong market positioning. Instead of buying 100 shares for $10,000, she decides to use long term options to gain leveraged exposure.
Sarah purchases one long term call option contract on Company X with a strike price of $105 and an expiration date two years in the future, paying a premium of $12 per share, or $1,200 for the 100-share contract.
After 18 months, Company X's stock price rises to $130 per share, exceeding Sarah's expectations. The long term call option, which was initially out-of-the-money, is now significantly in-the-money. Sarah can choose to exercise her option to buy 100 shares at the $105 strike price (total cost: $10,500), then immediately sell them in the market for $13,000, realizing a gross profit of $2,500. Her net profit, after accounting for the $1,200 premium paid, would be $1,300. Alternatively, she could simply sell the call option itself in the market, likely for a much higher price than she paid, without ever taking ownership of the shares. This hypothetical scenario illustrates how long term options can offer substantial returns with a lower initial capital outlay than direct stock ownership, provided the underlying asset moves favorably within the extended timeframe.
Practical Applications
Long term options serve various practical applications in investment and risk management strategies:
- Long-Term Speculation: Investors who have a strong conviction about an asset's long-term growth potential can use long term call options to participate in potential upside appreciation without committing as much capital as buying shares outright. This strategy offers significant leverage.54, 55
- Portfolio Hedging: Long term put options can be purchased to protect a long stock portfolio against significant downturns over an extended period. This acts as an insurance policy, limiting potential losses while allowing the investor to maintain their underlying stock positions.52, 53
- Capital Efficiency: By requiring less upfront capital than purchasing an equivalent number of shares, long term options free up capital that can be deployed elsewhere, enhancing overall portfolio diversification.51
- Dividend Capture Alternative: For investors seeking exposure to a stock's price movement without concern for dividend income or shareholder rights, long term call options can be a capital-efficient alternative to owning the stock directly, especially when the focus is on long-term capital gains.50
- Alternative to Short Selling: Bearish investors can buy long term put options as an alternative to short selling stocks, limiting their maximum loss to the premium paid, whereas theoretical losses from short selling are unlimited.
The official guidance from The Options Clearing Corporation (OCC) and the Options Industry Council (OIC) outlines the comprehensive characteristics and risks associated with standardized options, including long-term varieties, emphasizing the importance of informed decision-making for investors. [Theocc.com/company-information/documents-and-disclosures/characteristics-and-risks-of-standardized-options]
Limitations and Criticisms
While long term options offer strategic advantages, they also come with inherent limitations and criticisms that investors must consider:
- Premium Cost: The longer expiration period of long term options means they generally carry a higher premium compared to short-term options on the same underlying asset, reflecting the greater amount of extrinsic value or time value. This higher cost means a larger upfront investment and a greater potential loss if the trade does not pan out.48, 49
- Time Decay (Theta): Although long term options experience slower time decay initially compared to short-term options, they are not immune to it. As the expiration date approaches, particularly in the final months, the rate of time decay (Theta) accelerates, eroding the option's value if the underlying asset's price does not move sufficiently in the desired direction.44, 45, 46, 47
- Liquidity: Long term options, especially those far out-of-the-money or on less popular underlying assets, may have lower trading volumes and wider bid-ask spreads than shorter-term options.43 This reduced liquidity can make it more challenging to enter or exit positions efficiently at favorable prices.42
- Volatility Sensitivity: Like all options, long term options are sensitive to changes in the implied volatility of the underlying asset. A decrease in implied volatility can negatively impact the option's premium, even if the underlying stock price moves favorably.40, 41
- No Shareholder Rights or Dividends: Buying a call option does not confer shareholder rights, such as voting rights or the receipt of dividends, unlike owning the actual shares.39 While dividends are typically priced into option premiums, the direct benefit of dividend income is foregone.38
- Expiration Risk: Despite the extended timeframe, long term options still have a finite life. If the underlying asset does not reach the desired strike price or move sufficiently by the expiration date, the option can expire worthless, resulting in the total loss of the premium paid.36, 37
Long Term Options vs. Short Term Options
The primary distinction between long term options and short term options lies in their expiration horizons and the implications of this timeframe on their characteristics and utility.
| Feature | Long Term Options (LEAPS) | Short Term Options |
|---|---|---|
| Expiration | Typically 9 months to 3 years or more.33, 34, 35 | Ranging from a few days to a few months (e.g., weekly or monthly options).32 |
| Premium Cost | Generally higher, due to greater time value.29, 30, 31 | Generally lower, due to less time value.28 |
| Time Decay | Slower rate of time decay (Theta), especially in the initial months.25, 26, 27 | Rapid rate of time decay, accelerating significantly as expiration nears.22, 23, 24 |
| Timing Pressure | Less pressure for immediate price movement; more forgiving for long-term trends.21 | High pressure for quick, significant price movement; sensitive to precise timing.19, 20 |
| Sensitivity | Less sensitive to short-term volatility swings and Gamma effects.18 | More sensitive to short-term volatility, earnings-related volatility crushes, and Gamma.17 |
| Liquidity | May have lower trading volume and wider bid-ask spreads, especially for less popular assets.16 | Typically higher trading volume and tighter bid-ask spreads for active securities. |
| Use Cases | Long-term speculation, capital-efficient long exposure, long-term portfolio hedging.15 | Short-term speculation on immediate events (e.g., earnings), income generation (selling options), or quick directional bets.13, 14 |
Confusion often arises when investors treat long term options with the same short-term speculative mindset applied to weekly or monthly options. While both provide [leverage](https1, 23[4](https://www.home.saxo/content/articles/options/understanding-[11](https://optionstranglers.com.sg/blogs/news/long-term-vs-short-term-options-pros-and-cons), 12long-term-options-for-strategic-portfolio-management-13052024)5, [6](https://www.reddit.com/r/options/comments/18b2aky/cons_of_lon[8](https://www.motilaloswal.com/learning-centre/2023/6/what-are-long-dated-options), 9, 10gterm_options/)7