Your Best Option for Cashing In on LEAPS

Long-term options can be a great way to get more reward for the risk.

Tim Beyers
Tim Beyers
Jan 31, 2014 at 11:11AM
Investment Planning

You should rarely bet on long-term options in a taxable account, Fool contributor Tim Beyers says in the following video.

Why? Taxes. LEAPS, or long-term equity appreciation securities, are options to buy (or sell) stock at a certain "strike" price within a defined time period -- 18 months to two years is typical.

Profits collected after holding LEAPS for at least a year and a day are taxed at long-term capital-gains rates when the securities are held in a taxable account. Holding them in a retirement account defers taxes entirely -- a nice bonus if you've had a big winner that needs cashing out before the contract expires.

Tim has seen this process at work, cashing in a 10-bagger in Netflix LEAPS held in his SEP-IRA. Now, he's looking at Pandora Media (NYSE:P) LEAPS as a potential new buy, figuring that the company -- whose business depends on helping listeners discover new music -- occupies a defensible niche between single-track and album stores such as iTunes and Amazon.com and playlist organizers such as Spotify.

Buying 2016 LEAPS at a $30 strike would cost roughly $12.50 apiece. Thus, were Pandora to rise to, say, $60 on or before January 2016, Tim says he'd be sitting on at least a double. If he's right, holding in the IRA would allow Tim to realize the gains at any time without kicking off a taxable event.

Now it's your turn to weigh in. What's your strategy for cashing in on LEAPS? Do you use them in your retirement account? A taxable account? Please watch the video to get Tim's full take and then leave a comment to let us know whether you would buy, sell, or short Pandora stock at current prices.