Option Investor
Educational Article

Out With The Old, In With The New

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It is hard to believe, but spring has sprung and with the new growth springing up around us, it seems a good time to cover the topic of the LEAPS life cycle. May expiration ushers in the process of changing the front year LEAPS (in this case 2003) to regular option symbols, and this is quickly followed by the issuance of the new out year LEAPS (in this case 2005). Since the process whereby this happens is less than straightforward, I think it is high time we have a little review. Old-timers will recall that I cover this topic about this time every year, as we can all use a refresher due to the fact that we really don't think about it during the course of the year.

There always seems to be a fair amount of confusion surrounding this process, both why it is necessary and how the process works. Since I've actually been through it a few times, let me see if I can clear things up.

In the past, all of the changes took place at once, but a few years ago, the CBOE had to stagger their approach due to the huge volume of options that are now traded. Now the process takes place over a period of just over 2 months, beginning the week before May expiration and ending about a week after July expiration, with roughly a third of the Leap-able stocks receiving their 2005 LEAPS shortly after each expiration event. Making the educational process easier, the CBOE has put together a tutorial explaining the process and those interested in taking the time can begin their process of discovery Here.

Since I know many of you don't want to take the time to go through the whole tutorial just to obtain some simple answers, let me see if I can cover the highlights for you here.

If you are like me the first time I encountered this process, you are scratching your head and asking what this 'conversion' is and what it means to a LEAP trader. Fortunately the answer is fairly simple. All 2003 LEAPS symbols begin with the letter 'V' and all 2004 LEAPS begin with the letter 'L'. Since the CBOE only carries LEAPS for 2 years at a time, before the 2003 LEAPS can be issued, the 2003 LEAPS must be converted to regular cycle Call (or Put) options expiring in January of 2003. This conversion refers to the simple process of changing the symbol from a LEAP symbol to a regular option symbol. And here's a little sneak preview -- the 2005 LEAPS will all begin with the letter 'Z'.

In the case of MSFT, the 2003 $55 LEAP (VMF-AK) changed to a January 2003 $55 Call (MSQ-AK) on May 13th. There is no change in the way the option trades when it is converted, except that it is now referred to as a Call (with a different symbol), rather than a LEAP. There is no change to the 2004 LEAPS at this time except that they now become the front-year LEAPS. Next year at this time, the 2004 LEAPS will undergo a similar conversion process as the 2006 LEAPS become available.

The LEAPS expiration (conversion to regular Call Options) occurs in 3 cycles. The cycle 1 2003 LEAPS are converted to regular options on the Monday prior to May expiration (in this case, May 13th) and then the Cycle 1 2005 LEAPS are issued on the Monday, 1 week after the May expiration event. So with the Memorial Day holiday pushing it out to Tuesday this year, the 2005 Cycle 1 LEAPS will arrive on Tuesday, May 28th.

Extending that process out to the Cycle 2 LEAPS, the 2003's will convert to regular options on Monday, June 17th and the 2005's will be issues on Monday, July 1st. Finally, the Cycle 3 2003 LEAPS will convert to regular options on Monday, July 15th, with the 2005 LEAPS making their appearance on Monday, July 29th.

I know you are all champing at the bit, wondering how do you find out if a given stock is on Cycle 1, 2 or 3. I'm way ahead of you, and after speaking with a very helpful gentleman at the CBOE, I found that there is a quick shortcut we can use to make the determination. Pull up an option chain on the stock in question. It will have option chains listed for June and July, as these are the 2 front months at the current time. The next month that is listed gives us the clue as to which Cycle the stock belongs to. If the next month is October, then it is on Cycle 1. Note that this is the case with MSFT, which began the conversion process just over a week ago. If the next month listed in an option chain (after June and July) is August, then the stock is Cycle 2 (conversion process in June). Finally, if September options are the third month listed in the option chain, then the stock resides in Cycle 3.

Wasn't that easy? No scrolling through endless lists of equities and LEAP symbols looking for the one in question to find out what cycle it belongs to. All we do is bring up the option chain and the months listed tell us which Cycle it belongs to. And with the dates provided above, you should be able to determine precisely when any stock you are interested in will begin and complete its conversion process. One note I should make is that this trick only works like this AFTER May expiration. If we had been looking at this prior to May expiration (before all the July contracts had been issued), then the month/cycle relationship would be a little different, and perhaps make a bit more sense. Prior to May expiration, stocks with July contracts would have been Cycle 1, those with August contracts would be Cycle 2 and those with September contracts would be Cycle 3. Hopefully I haven't made that too confusing!

Should you want to determine if a stock has LEAPS available, the CBOE provides a comprehensive list of all optionable stocks at http://www.cboe.com/TradTool/Symbols/SymbolDirectory.asp. Then selecting the link for LEAPS near the top of the page will give you a list of all equities with LEAPS available. So if you ever question whether a stock has LEAPS available, this is the central repository for that information. Of course, you can always just pull up an option chain and see if there are options listed out to 2003 and 2004, and that will give you the answer.

I know this has been a rather dry article, but hopefully it gives you a roadmap for determining when to expect the issuance of the new 2005 LEAPS for any stock in which you happen to be interested.

Happy Exploring!


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