Why You Should Consider Using Deep ITM LEAPS Calls to Replace Stocks

When it comes to making bullish bets on stocks, many traders and investors look for ways to maximize capital efficiency while minimizing risk.

One approach that has gained popularity is using deep In-The-Money (ITM) LEAPS calls as a replacement for outright stock purchases.

But what exactly are LEAPS, and why might this strategy be beneficial for you?

What Are LEAPS?

LEAPS (Long-term Equity Anticipation Securities) is basically a fancy name for options with long expiration date.

Different people have slightly varying definitions of what qualifies as a LEAPS option, but I typically consider any option with an expiration of more than one year to be a LEAPS.

Because they are long-dated, LEAPS allow investors to take directional bets with a much longer time horizon than typical short-term options.

This makes them ideal for those with a bullish view but who want to employ less capital than buying stock outright.

Capital Efficiency and Risk Reduction

The key benefit of using deep ITM LEAPS calls to replace stocks is capital efficiency.

When you buy stock, you commit 100% of your capital to control 100 shares.

However, with LEAPS, you can often control the same number of shares with 50% or less of the capital.

This allows you to maintain the same bullish exposure, but with much less capital at risk.

This is especially important in volatile markets or when you’re looking to diversify your portfolio across several stocks.

Why Deep ITM LEAPS?

When you select deep ITM LEAPS calls (typically those with a delta of 0.70 or higher), you gain several advantages:

1. Minimal Extrinsic Value And Low Theta Decay

Deep ITM LEAPS carry mostly intrinsic value and minimal extrinsic value. 

With minimal extrinsic value, theta decay (the loss in option value over time) is also low, meaning you incur only a small daily cost to maintain your call position.

2. Replicate The Returns Of Owning Stock

With a deep ITM call option, the high delta closely mirrors stock ownership returns.

For example, a call option with a 0.80 delta behaves like holding 80 shares; every $1 increase in the stock price raises the option’s value by $0.80.

As stock prices rise, the delta value also increases, bringing returns progressively closer to those of stock ownership.

3. Opportunity To Sell Calls To Lower The Breakeven Price

Using a long call as collateral enables you to open a short call position for credit, effectively lowering the stock’s breakeven price—a strategy known as the Poor Man’s Covered Call.

Typically, the covered calls are initiated with a shorter duration of 30-45 DTE at a 0.20-0.30 delta. The premiums earned more than cover the theta decay.

While the upside is capped by the short call, this delta range still allows for capital appreciation from the long call.

Delta Selection For LEAPS Call

Delta measures how much the option’s price changes in relation to the underlying stock’s price movement.

I prefer deep ITM call options that have a higher delta, usually around 0.70 or higher. This means for every $1 move in the stock’s price, the option price will move by approximately $0.70.

Keep in mind that delta is dynamic. As the stock price rises, the delta value increases, meaning the option’s behavior becomes more similar to owning the stock as its price goes up.

While the upside from deep ITM LEAPS is slightly lower than the stock (unless delta is very close to 1), the trade-off is well worth it.

Your downside risk is significantly reduced since your maximum loss is limited to the premium you paid for the option.

In addition, as the stock price falls, the delta decreases, meaning the option loses value more slowly compared to the stock’s decline.

Safer Way To Leverage

Let’s assume you have $10,000 to invest. Instead of committing the entire amount to one stock, using LEAPS allows you to spread your capital across two or more stocks by only using about a portion of the capital for each position.

With the downside capped at the premiums paid, this approach offers a safer way to leverage compared to using margin.

This not only reduces your potential losses but also allows you to diversify your risk, thereby increasing your chances of achieving consistent returns.

Stock Selection Is Key

This strategy hinges on selecting the right stocks.

Since you are using deep ITM LEAPS, you want to pick stocks with strong bullish potential and solid fundamentals.

These are typically companies you are confident will increase in value over the next 1-2 years. 

I typically look for S&P 500 stocks with strong fundamentals and an up trending chart as good candidates for this strategy. The approach is quite similar to the mindset of a buy-and-hold investor.