Newbie investor question. Suppose I have a significant asset allocation in individual stocks - close to 30%-40% (due to employer grant, active stock picking etc). I would like to sell them gradually and buy passive index funds. However I still believe that some of these companies will go up over the long run. Is it a good idea to substitue these individual stocks position with call options with long time horizon expiry date, so I can still profit if these stocks go up, and reduce the active investing allocation of my portfolio to a much smaller amount?
Obligatory not a financial advisor: You may want to re-evaluate what you want to do: 1. Some of these companies will go up in the long run How do you know? What kind of analysis have you done? If this is the case, LEAPS are an excellent use of capital for this purpose - however with leverage they can turn on you just as fast. If you already hold the stock - why not sell covered calls against it? If you sell your stock and then buy LEAPS all you are doing is levering up way higher with no real reason. 2. Reduce active investing to a smaller account This point excludes (1) from consideration. If your goal is to reduce your actual time-in-market doing research then you are only going to be best served by index funds, mutual funds, or ETFs. You should be aware indexing isn't a panacea and comes with it's own risks. If you want to get rid of stock, sell call options against your stock until you have had enough called away. You'll want to sell at a point you'd still be getting out at a profit according to your cost basis. When you're wrong, ideally you'll collect enough premium to cover the losses on the actual underlying.
Short answer is yes. However, it is not cost free. To exit gradually but if you want to protect your gain, maybe you should also add a no cost collar.
Why? I sometimes use no cost collar to protect my position, lock in the gain and push the close to the next tax year.
Using a high delta call LEAP as a surrogate for the underlying is called a Stock Replacement Strategy. Assuming that the implied volatility is reasonable, because the call is deep ITM, you'll pay a modest amount of time premium and you'll have very little time decay (theta) in the early months, even longer if it's a two year LEAP. The call LEAP will lag the underlying not only by the amount time premium paid but by the dividend as well (if any) which goes to the share owner. It's not because the dividend is a profit to the shareholder but because the LEAP's price drops by the amount of the dividend going into the ex-div date. In return, you will lose less on the call LEAP if the underlying collapses. On an expiration basis, below the strike price the shareholder continues to lose whereas the LEAP owner loses nothing beyond the premium. Prior to expiration, as the stock drops, the delta of the call will drop which means that the call LEAP will lose less than the stock for each dollar of underlying drop. How much? It depends on the size of the drop, when the drop occurs, and what the implied volatility is at that later date. Suffice it to say, the call LEAP will lose less. A benefit of LEAP ownership is that if the underlying rises nicely, you can roll your call up, pulling money off the table and maintaining your risk level, something you can't do with long stock. You'll give up some delta but you'll repatriate some principal, lowering your cost basis. If you have an upside target price where you'd be willing to sell, you could sell a nearer term call against your call LEAP, creating a diagonal spread. The credit received would offset some of the time premium paid for the call LEAP. If it expires, wash, rinse, repeat. This is often called the Poor Man's Covered Call.
A no/low cost collar is a good idea to protect positions, particularly if they are highly concentrated in a few stocks. For the OP, the collar converts the long equity to the equivalent of a vertical spread (or diagonal spread if you buy a long put with a later expiration). Pushing the gain until next year requires a cooperative underlying.
Not sure how LEAPS increases leverage, per se. However, to cut premium costs, consider a synthetic long as a stock replacement strat.
No leverage if you replace 100 shares with one call LEAP. Using the cash differential to take on additional positions would be leverage.
Flip your strategy. Keep your stocks, and buy index futures as a replacement for tying up funds in index funds. Options strategies as a replacement for underlying equities will ALWAYS carry additional costs and hassles.