In his book "You Can Be a Stock Market Genius," Greenblatt lays out some of the strategies he used to generate these extraordinary returns. One of those strategies is using LEAPS, which stands for “long-term equity anticipation securities.”
Put simply, LEAPS are a special type of call option with a long-term shelf life. (Puts are also available.) LEAPS are available on hundreds of securities and can extend out as far as 30 years.
A big advantage of LEAPS is that they allow you to benefit from price movements of a large amount of stock with a modest amount of capital. Instead of buying $10,000 worth of shares, for example, it is possible to buy just a few hundred dollars worth of LEAPS and still have similar profit potential.
Better still, this smaller amount becomes the maximum amount of money you can lose if your investment goes against you.
So if investor “A” buys $10,000 worth of stock -- tying up a large portion of capital and exposing himself to downside risk on the entire amount -- investor “B” can use LEAPS to enjoy comparable upside potential with a fraction of the capital and a fraction of the downside risk.
Greenblatt describes how he used LEAPS to profit from a bullish investment situation in the early 1990s. Wells Fargo, the mortgage behemoth, was trading for $77 per share, having suffered through one of the worst real estate recessions since the 1930s.
In fact, in 1992, things were so bad in the commercial real estate market that investors were wondering whether Wells Fargo would survive the downturn. Even if it could have rebounded modestly, Wells Fargo stock was so depressed that the share price could have easily doubled over the course of a year or two.
There was just one problem. What if some hidden risk lurked on the balance sheet? What if the depressed share price was justified? How could Greenblatt protect his downside, while still capturing a big upside move?
Greenblatt decided to invest using LEAPS…
He later described the Wells Fargo LEAPS investment as “a great chance for a double with a remote possibility of disaster.” LEAPS allowed him to catch the upside if he were right. But even if he were wrong, the risk of the LEAPS position was limited to the cost of his purchased options.
As it happens, Greenblatt was right about Wells Fargo. And his LEAPS investment was a home run. Wells Fargo shares more than doubled. But Greenblatt’s LEAPS did even better. They returned in the neighborhood of 500%.
Not all LEAPS will deliver these kinds of returns. But they are an excellent way to lower your capital costs, reduce your risk and boost profit potential.
If you would like to find out more about LEAPS, look for my special report on the subject (coming soon).