Equity LEAPS Calls vs. Stocks: An Empirical Study for Long-Term Speculation
15 Pages Posted: 29 Aug 2011
Date Written: August 29, 2011
Long-Term Equity Anticipation Security or LEAPS is a call option introduced as a more conservative security that can replicate a common stock position. This study’s objective is to examine the effect of applying the strategy of “Buying In-the-Money LEAPS Calls vs. Purchasing Stocks” proposed by CBOE on the performance of traders in terms of risk and return trade-off and the risk-adjusted performance in practice, using a sample of 54 common stocks listed on NYSE and NASDAQ and 54 LEAPS calls on the same underlying stocks listed on CBOE during 2008-2010. The results indicate that LEAPS calls are not a preferred financial instrument to replace common stocks for risk-averse traders. When the stock market experiences a progressive downturn trend, the portfolios of LEAPS calls provide much higher negative returns, significant loss and poor performance as well as higher levels of volatility relative to the portfolios of common stocks. The results of this study also suggest that risk-seeking traders, who can tolerate the higher level of risk in compensation for higher returns, choose the portfolio of LEAPS calls with high Book-To-Market (BTM) ratio assets. This portfolio is less volatile relative to the portfolio of LEAPS with low BTM ratio and provides higher rates of return in comparison to the portfolios of common stocks in favorable market conditions.
Keywords: Equity LEAPS call, common stock, long-term speculation, return, volatility, mean, variance, risk-adjusted performance, Sharpe ratio, Treynor ratio, Jenson Alpha
JEL Classification: G11, F39
Suggested Citation: Suggested Citation