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The potential for profits with options trading is vast. But options contracts are influenced by the passage of time. So, timing is paramount. With that in mind, traders often focus on long-dated options for profits. Dive into this article to learn all about them.
Understanding long-dated options
The long-dated options enable the trading of agreements with expiration dates spanning from nine months to three years. This strategy helps reduce risks in case the market or a particular stock is overvalued in the future, with a chance of a correction.
These options typically expire on the fourth Thursday of the month. If the expiration date coincides with a public holiday, settlement takes place a day earlier.
They are similar to monthly options but with variations in duration. Investors often take positions in these options to mirror the exposure of index futures.
Types of long-dated options
Traders will come across two types of long-dated options contracts.
- Call: This type of option is offered to purchasers. It enables them to benefit from an increase in the market. This is possible because the purchaser can still buy the asset at the predetermined price, regardless of any changes.
- Put: The long-dated put options are offered to sellers. It enables them to benefit from a decrease in the market. This is possible because the vendor can still offload the underlying asset at the predetermined price, regardless of any changes.
Characteristics of long-dated options
Some key characteristics of long-dated options contracts are as follows:
- Strike Price and Quantity: These characteristics assist traders in reducing risks associated with fluctuations over time.
- Minimum Nine-Month Maturity: Options with long expiration dates typically cover at least nine months.
- Limited Advantage in Bull Markets: Although they protect against market declines, they may not result in significant profits when the market is on an upswing.
- Risk Reduction: Long-dated options help mitigate risks linked to traditional options trading by allowing for a longer holding period of the asset.
- Investment Diversification Opportunity: They offer a secure method to spread out your investment portfolio.
- Flexible Expiration: By having extended expiration periods, you can evaluate the market and make trades when conditions are favourable.
Benefits of long-dated options
Some key advantages of long-dated options contracts:
- Diversification: Opting for long-term options enables you to broaden your investment collection. This agreement can be exchanged with basic properties like goods, equities, currencies, or other types of assets.
- Risk Mitigation: This derivative empowers you to safeguard your possessions if the market is in an excessively purchased area, and there is a likelihood that it will decline to rectify the discrepancy.
- Economical: These deals are accessible for a minimal fee. You can utilise 10-20 times the long-dated options contract value worth with a small initial capital.
Buying long-dated options in the Indian market
Are you wondering how to buy long-dated options in the Indian market? To do that, you should know that these contracts are called LEAPS in India. The options contracts that are traded publicly have a longer duration, typically between one to three years. However, there is a limitation.
LEAPS are only accessible for the Nifty50 Index, and the returns they offer may not be as high as those from riskier short-term contracts. While long-dated options are heavily traded in the US markets, their presence in the Indian market presents a distinctive scenario.
Apart from long-term options, there are various other options strategies to consider, such as the iron condor and calendar spread. Each strategy provides a distinct way to navigate through different market conditions, but they also come with their own set of risks and complexities.
Setting up LEAPS
LEAPS are initiated just like any other options contract. A trader can either go long or short a position by choosing a contract from the options chain. However, the expiration date must be at least one year ahead to be considered a LEAPS contract.
The extended time to maturity will result in a higher price. Therefore, the options will carry a significant amount of extrinsic value.
The Greeks play a crucial role in determining the price of the option. The longer timeframe makes the option’s value more responsive to changes in implied volatility and interest rates of the underlying stock.
Entering LEAPS
LEAPS is not much different from stepping into short-term options agreements. The prices and pertinent details can be found on the options lineup. You can either purchase, sell, or mix these options, similar to any other options agreement.
The main contrast lies in the pricing in comparison to short-term options. LEAPS tend to have higher prices, but this is the trade-off for gaining cost-efficient, extended exposure to stocks.
Exiting LEAPS
Exiting long-term options is similar to exiting brief options contracts. If the option has an American-style expiry, the position can be closed before the expiry by reversing the initial order.
If a long call was bought to open the position, it would be sold to close it. If it is sold for a higher price than it was purchased for, a profit will be made.
American-style options can also be exercised before the expiry. If the option has a European-style expiry, closing the position is not an option. The option will be settled in cash on the expiry date.
Difference between short-dated and long-dated options
Some of the key differences between long-dated and short-dated options are as follows:
| Criteria | Long-dated options | Short-dated options |
| Period | They usually have a maturity period of 9 to 36 months. | They usually are available for less than three months. You will also find weekly and monthly short-dated options contracts in the market. |
| Cost | They are usually more expensive than other types of option contracts. | They are usually less expensive than other types of options contracts. |
| Time Impact | Long-dated options contracts don’t lose value because of time decay. They are risky because of leverage and might lead to increased losses. | Short-dated options start to lose their appeal as they start approaching their expiry date. This leads to counterparty risks. |
| Style of trading | European and American | European and American |
Closing Thoughts
Long-term options provide significant diversification possibilities to traders of options while also providing a chance to make profits with minimal investment. As a result, investors can allocate funds to the same asset with different time frames and generate returns in the near and distant future. Nevertheless, if you are considering entering the market with long-dated options contracts, it is important to understand that they are limited to fewer than 100 stocks and do not offer dividends like stocks do.
FAQs
Long-term options contracts last for at least 9 months. They can also be valid for as long as 3 years.
Long-term options contracts are called LEAPS in India.
LEAPS offers investors the opportunity to capitalise on increases in stock prices with lower capital investment compared to buying the stock outright.
The strategy of a call option with a long expiration date is optimistic and entails purchasing it with a far-off expiry and a strike price at or just above the present asset value. This plan seeks to benefit from a continuous rise in asset prices over time while limiting potential losses to the premium of the option.