Enhanced Indexing Strategies: Utilizing Futures and Options to Achieve Higher Performance

CHAPTER 6

Rolling LEAPS Call Options Explained

In Chapter 4 we showed that longer-term call options are, on average, a better value than shorter-term options because of their ability to capture more appreciation for only a marginal increase in cost. As a result, any call option can be made more valuable by extending its life; that is, selling the option and replacing it with an identical one, but with a later expiration date. This technique is called rolling an option forward.

This chapter applies this technique to extend both the lifetime and the potential value of LEAPS call options. This practice can allow an investor to maintain a leveraged, hedged position on an index for a period of years. Like every strategy in this book, this one is presented both as a viable method for benefiting from long-term index appreciation and a foundational strategy for learning advanced concepts in indexing and options. Again, we advise against assuming that later strategies are better, as each has its own merits.

Rolling LEAPS Call Options is a simple strategy to execute, has a high degree of predictability in cash outflows, is relatively low risk, and has low transaction costs. However, it also has significant hidden complexity, and because of its long-term nature may trap investors into low returns or unexpected losses several years later.

For these reasons, we devote both a concept chapter and a strategy chapter to this strategy, as much of what we learn can be applied to both spread-based ...