J Raymond:“I noticed in a recent column that you discuss owning some MSFT LEAPS. I was wondering if you could provide a brief discussion of when and why you use LEAPS. The reason I ask is that I too have traded LEAPS in several technology stocks, but coincidentally it’s from reading your many tax-related columns that I’ve begun to think this is actually a fairly ‘tax-inefficient’ way to invest. In other words, I’m wondering if it doesn’t violate some of the tenets of what you’ve been advocating since it introduces time limits (albeit fairly broad ones) during which I must realize capital gains on these investments. In that sense, it strikes me that I’ve created a strategy similar to a mutual fund where I am forced to take a capital gain during a set period whose end date is of course the LEAP expiration date, and thereby lose some of the ability to control my own tax destiny.”
☞ LEAPS are long-term options, currently going out as far as January 2003 — a little more than two years from now. So one tax ramification is that, at least as against regular options, you can hold for a year and a day and qualify for the lower capital gains treatment. (I’ve also used them in my Keogh Plan, where any taxes are deferred.)
I am not a big fan of options, and would use LEAPS sparingly. After all, with either one, you are quite likely to lose 100% of what you gamble.
Mathematically, they will rarely be offered at prices much different from their “true” value based on the time value of money, the volatility of the underlying stock, and so on. I know that. But what if you just think Steve Jobs’ coming back to run Apple is going to make this thing huge — you just “know” it — and you want to go with that hunch?
I didn’t personally “know” it, although I am as awed as anyone else by Steve Jobs’ talent. Rather, I was inspired by Mark Anderson’s assessment in his Strategic News Service newsletter. His hunches are better informed than mine. I bought 10 Apple LEAPS in November, 1997, for $4 and change, giving me control of 1000 shares of the stock. (Each options contract is for 100 shares. If the option is quoted at $4, that means the contract costs you $400 plus commission.) I gave them away this past January when they were $81 and change. I thus saw $4,000 grow to $81,000 in two years, and got an $81,000 tax deduction for donating the securities. It was anything but typical of my experience with options. Or LEAPS. But if there’s some stodgy or out of favor stock you think will really take off, and if LEAPS are traded on that stock, they could be worth a look.
I would guess that most speculators don’t have the patience for LEAPS, preferring the even greater leverage and excitement of shorter-term options. If so, LEAPS may at least sometimes be priced with less of a frothy speculative premium. Also, they do give you that potential long-term capital gain tax advantage.
All that said (drum roll, please, for the obligatory pun), the wise man looks very carefully before he leaps. Ba-dum-bum.
Quote of the Day
Governments are necessarily continuing concerns. They have to keep going in good times and bad. They therefore need a wide margin of safety. If taxes and debt are made all the people can bear when times are good, there will be certain disaster when times are bad.~Calvin Coolidge
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