asking about buy options ITM and OTM in earnings play

Discussion in 'Options' started by d.tradersam, Jun 19, 2010.

  1. Dear experienced fellows,

    i just want to ask something about options since i need more explanation about ITM and OTM

    i tried to buy ITM call and OTM call three days before earning announcement from fedex . At that time the price was about 80.
    Because i had a perspective it's bullish, so i tried it in paper trading (because i have no idea about this company, and i haven't played on earnings yet)
    i bought 80 call june 2010 and 85 call june 2010.
    Well. although it's bulllish, it just moved slightly. But when i compare the gain result, the 85 call was more profitable than 80 call
    is it good or better using OTM then ITM/ATM when playing earnings (if we're sure about the direction) ? why ?

    thank you for someone who can explain this :)
  2. stoic


    The selection of Strike Price in relation to the underlying is a matter of Risk vs. Reward. The probability that a ITM Call will expire worthless is less than that for the OTM Call. The OTM offers both larger potential risk and larger potential reward. Your tolerance for risk and your exspectations on the underlying should dictate what strikes you use in each applacation of this strategy.
  3. white17


    The percentage gain on the OTM call is greater of course because you have less money in the position initially. BUT, the delta on the ITM is higher so that contract will appreciate (decline) more in absolute terms given the same gain (loss) on the underlying.

    I would suggest not making option plays going into earnings at all. You can be correct about the direction and still lose because of the collapse in IV after the announcement.
  4. So, this is all about volatility and delta which give an impact for the premium.
    Thank you stoic and white17 for explanation and suggestion
    Any other comments would be appreciated.
  5. Prior to earnings, IV should have been increasing. After the earnings news, IV decreased (if it was elevated in anticipation of release). ITM call has wider spred and if not looking at real time, amount of change can be deceptive.

    and since FDx was spanked on release and dropped below your strikes, also hard to figure how either made money so hard to answer your question since dates and prices not posted.

  6. yes, theohornsby
    i admit that i forgot the premium of both options, but what i do remember is, one day before earnings report, a more profit came in OTM than ITM call. And then in the next day, it just dropped due to IV, even they gave a nice earning report.
  7. Are you sure? I think the reason is that gamma of OTM is lower than gamma of ATM (max gamma). If stock moves towards OTM, gamma of OTM rises and gamma of ATM declines, which makes the percent gain of OTM higher than percent of ATM.

    Notice that percent gain of both ATM and OTM is greater than percent gain of stock because gammas are non negative.
  8. white17


    Just calculating a simple percentage. If you realize a gain of 3$ on a 1$ investment (OTM) or 5$ on a 2.50 investment (ITM) the percentage gain on the OTM is greater simply because you invested less
  9. However, the deltas of ATM and OTM are not equal. For the same move in stock, you get different absolute dollar gains. Any comments?
  10. white17


    Of course.

    Not trying to be snarky here but don't try to over-analyze this. It's not that complicated. Think in terms of the position at expiration and evaluate the different outcomes and the probabilities before entering.
    #10     Jun 20, 2010