For the options trader, there are an almost infinite number of options available - pun intended - and it's important to understand your different choices and potential strategies before making a decision. For the trader with an advanced understanding of options and a long-term focus, Long-Term Equity Anticipation Securities^® (LEAPS) may be a viable portfolio addition.

An unintended result of such a fun acronym is that it can double as a mnemonic device: When you think about regular options contracts versus LEAPS, remember that LEAPS allow for a longer leap into the future than a traditional options contract. That's right - while a regular options contract lasts only a few days to a few months, maybe as long as a year, LEAPS expire up to three years from the contract date.

There are two kinds of LEAPS, equity LEAPS and index LEAPS. Their names require no mnemonic devices - equity LEAPS are options on shares of an individual equity interest, while index LEAPS are options on a compilation of several stock prices, a benchmark called an index.

Similarities
Both equity and index LEAPS have essentially the same features as a traditional options contract, but the focus is more long-term. In exchange for the payment of a premium, the holder of a put or call option on both kinds of LEAPS have the right (but not the obligation) to buy or sell shares of the underlying stock or the value of the underlying index at a particular price.

In exchange for a premium received, the writer of a put or call has the obligation to sell or buy shares of the underlying stock or the value of the underlying index at a particular price if the holder exercises the contract.

The premiums for equity LEAPS and index LEAPS are also handled the same way. LEAPS premiums are quoted in points, with one point equaling $100. So, a quoted premium of 1.25 equals $125, and a premium of 2.5 equals $250. For equity LEAPS, premiums are quoted on a per-share basis.

Differences
The obvious difference is that one type of LEAPS deals with equities and the other with indexes, and this single point is the source of other distinctions as well. First, the type of payout is affected. Equity LEAPS, when exercised, result in a transfer of shares of the underlying stock. Index LEAPS, when exercised, result in a cash settlement that is calculated as the difference between the strike price of the option and the intrinsic value of the contract, all multiplied by $100, which is the standard contract multiplier. Intrinsic value is vital to options contracts and means the dollar amount by which an option is in-the-money.

Another difference can be the settlement style. Equity LEAPS are considered "American-style options," which means they can be exercised at any point between the contract's inception and its expiration. Index LEAPS, on the other hand, may be either American-style or European-style, meaning they can only be exercised during a specific period of time just before the expiration.

Strategy Overview
Some investors will use LEAPS to diversify their portfolios without actually buying shares of a particular security or exposing themselves to a particular market segment (or the market as a whole, for that matter). Basically, LEAPS can allow an investor to watch the market over an extended period of time and create hedged or speculative positions without actually engaging with the market until the options are exercised.

Potential Benefits
Investors with a long-term outlook enjoy the extended time and flexibility of LEAPS..

As mentioned above, LEAPS also provide a potential for diversification with lower out-of-pocket costs. Premiums for LEAPS can be costly, but many times they are less expensive than buying an equivalent number of underlying shares in one or several securities. Investors can gain exposure to a security, market segment or the market as a whole with one trading decision and one transaction.

Additionally, LEAPS provide the same potential for leverage and protection that other types of options contracts can offer.

Potential Risks
Like other kinds of options trading, buying and selling LEAPS can be risky.

When buying a LEAPS contract, the investor risks losing the amount paid for the premium. In this case, the investor faces losing only a finite amount. However, there are many LEAPS investments that pose a far more significant, possibly unlimited risk. Examples include selling LEAPS puts or uncovered LEAPS - in both cases, the potential losses are great. It's important to remember that with LEAPS, as with any options trade, the possible downside increases significantly with the potential upside.

It's also smart to factor in the potential gains that can be missed if a LEAPS contract does not go the way the investor intended. And, if you are the writer of a LEAPS contract that is excercised, potential losses may significantly increase because of your obligation to carry out the contract.

Check out the Knowledge Center for additional articles and information about options and LEAPS. Or, visit Scottrade's OptionsFirst platform, which allows you to access educational materials and explore the platform before you decide whether options trading is right for you.

Options involve risk and are not suitable for all investors. Detailed information on our policies and the risks associated with options can be found in Scottrade's Options Application and Agreement, Brokerage Account Agreement and Characteristics and Risks of Standardized Options (available at your local Scottrade branch office or from the Options Clearing Corporation by clicking here). All option accounts require prior approval by Scottrade. Market volatility, volume and system availability may impact account access and trade execution.