Smitty,

You appear to be a good stock picker, but there is some indication you're a trader. To trade LEAPS successfully, imo, you need to be both.

First, setup a spreadsheet where you can compare investment opportunities and risks. Mine is setup to show the stock price, the strike and option price as well as the historical and implied volatities, open interest, estimated value of the option (from Value Line Options), the delta, theta and open interest. From these inputs, Excel automatically calculates the percentage change in the stock required to reach the stock break even point. It calculates the option price as a percent of the stock price and the strike price.

I also enter the percentage drop in the price of the underlying stock that I would sell the stock at.  Excel calculates my stop loss prices for the option and for the stock and the estimated loss on the option if I let the stock drop x% before selling out. Typically a 7% drop in the stock price will produce the equivalent of a 50% drop in the option price. In other words, I'm using LEAPS leverage my capital. If I'm willing to take a 7% or 8% or 10% drop in the price of the stock when I just buy the stock, I can take the same dollar amount in the options investment. I seldom take a 50% drop in my options investment speculation, by the way (btw). As most here know, programming Excel is basic algebra and math.

All of this is on one row in the spreadsheet for each potential trade. When I see caution signals, I use a yellow fill; when IV<HV i use green fill over the IV data; when HV>IV, I use red fill to warn me that the option is over priced. If a stock has to rise 40% or 50% to make the LEAP break even, I fill the percentage change box with red.

I use a row under the data row for notes, including the date of my calculation. I'll note whether the charts are positive or negative. I don't buy  call leaps on declining stocks. I Wait for them to bottom.

Yesterday, for example, I looked at several good possibilities that looked promising based on fundamentals and options prices. But when I looked at the charts, I put those trades on my watch list. I found one or two that I might do tomorrow.

The big problem I'm finding with the M* 5* stocks is that quite a few aren't traded on the options market or there are no active LEAPS for them. Also, 5* stocks often are still in the dumps, and you have to wait for them to show that they're on their way up before buying them. Otherwise, you are likely to be throwing good money after dead money. I"d rather pay more for options on a bullish stock than for options on a stock that hasn't bottomed. 

I agree with Steve that your profit objectives for LEAPS are too low. This is because you can see a 10% to 20% loss over night, and you have to make enough to more than cover those losses. I have a 113% gain on a LEAP that I bought last Dec. The stock is up 35% and still surging. I have an 8% loss on a leap I bought a couple of weeks ago. The stock is down 1% or 2%. And I have a 5% gain on a leap I bought a couple of weeks ago, and the stock is practically unchanged.

If you buy LEAPs, you should sell them six months before expiration to minimize losses due to decays in time premiums. Thus, I will sell my Jan 2010 LEAPS no later than July 1, 2010, and probably sooner 

Based on my experiences with LEAPS, I've decided small positions and more stocks are better than betting everything on a few great ideas. This requires more work, but I think it will minimize risks and losses and maximize profits.

What I'm doing is putting a small amount of money relative to the funds I want to put into LEAPS into each trade. I try to do 2 to four new trades each month so that I will have up to 30 positions at any given time. I figure I can make good money if half of the trades work out and I minimize my losses and let my profits run. I limit my losses to 3% to 8% of the value of the underlying stock, depending on the stock and market conditions. And I let profits run as long as the technicals look good. If the technicals go negative on a stock, I sell the LEAPS.
 

This is a nice way to juice your portfolio.  You probably know most of what I'm about to say, since you have clearly made a study of options and are a thoughtful trader.  But for the benefit of other readers, I'll write this anyway.

There is something to be careful about, and that is volatility changes (vega risk).  The prices of LEAPs are greatly affected by volatility.  Think of the LEAPS as akin to a bond.  A long-term bond's price will be affected more by interest rates than a short-term bond's price, and it is the same way with LEAPs versus nearer-month options. 

In addition, volatility itself fluctuates rapidly, so that high volatility tends to precede lower volatility, while low volatility begets high volatility.  For this reason, purchasing LEAPs calls or puts during periods of low volatility is safer than during high periods of volatility.  For example, if you purchase a call, it is possible that if the underlying rises while volatility falls, the LEAPs may stay the same or even lose value, even though you were correct about the stock. 

Of course, risk and reward are always inversely proportional, so that in exchange for the added safety of purchasing during periods of low vol, you may have to accept lower returns or wait longer for your returns to materialize. 

So this strategy is a fine one, but this may not be the best time to put a lot of capital into it.  Maybe watch the VIX daily, and keep most of your powder dry.  Vol could drop pretty quickly if the market gets mired in a trading range, which looks like a possibility for the near future.  Then you can jump in with both feet. 

Good luck.

 Mary

Since you asked jobowoo, I favor buying moderately ITM LEAPS. ITM options are more expensive but they tend to react better to the underlying stock and contain less time premium. The risk is that the stock declines and you lose intrinsic value, but the same goes for the stock itself.

You can get a bigger bang for your buck with OTM options, but I never buy these unless I can point to some catalyst that can vault the stock higher. One example of such a play would be M* recommendation on Mankind (MNKD) which is waiting approval for their drug this year. It is a win or lose proposition, so it is higher stakes. With conservative, well established companies in normal times, I always go with ITM options instead.

JMHO

Steve