This is misguided, IMO. Maybe one of the LiveVol boyz is arnd to, hopefully, point out the error of your ways. They like to point out the various flows they see.
Agreed. When I first started using options I tried buying some OTM options on a clearly uptrending stock. Well, the option sellers weren't stupid. They priced a lot of volatility into those options. As it was, I was lucky -- the uptrend continued just enough that I was able to sell at break even. I'd have done a lot better with ITM options (and perhaps selling OTM puts and/or doing a vertical spread). Needless to say, arguing that OTM options are better because BS under estimates the true probabilities of large price swings is silly. Every professional option trader knows BS inside and out *and* is fully aware of its limitations. They know which stocks have log price change distributions that deviate from a normal curve and price accordingly. Option prices are set by the market, not blindly by a simple formula, and the fact that the market makers stay in business shows they don't usually misprice their options too badly.
A fair question, and there's no hard and fast rule. The deeper in the money the higher the delta, the lower the leverage, and the less the time value -- in short, the more the option acts like the underlying asset. High delta is good. If the underlying stock creeps up 0.25 an in the money call with a delta of 0.7 should go up at least 0.15 while some OTM call you bought for 0.30 might not go up at all -- especially if time is ticking by so your negative theta is working against that small delta. Which brings up the other point -- the smaller time value of the ITM call. That's also good, because that's the money you'll lose if you have to wait while the underlying asset goes nowhere. Too many beginners just look at the leverage (the only advantage of the OTM options), largely because of excessive optimism. (High leverage is great *if* the underlying asset moves in the direction you hope and as far as you hope, but experienced traders know that hope isn't a good basis for a trade.) So the bottom line is, consider different strike prices, and work out how they'll behave as the underlying asset moves by different amounts *and at different times* (taking time value into account). Ask yourself, "What do I lose if I'm wrong?" Also consider more complex option combinations that can make your net theta less negative or even positive, and lower the overall cost. But in that case make sure you have a broker with cheap option commissions.
Correct me if I'm wrong here, but don't equity vols almost always exhibit a smile? Given that, wouldn't buying deep-in-the-money options necessarily entail paying quite a bit for the vol? And, if that's the case, wouldn't you rather just punt the underlying?
Well, you are paying more for the volatility on the little bit of the option price that is time value, but there isn't much time value on a deep in the money option. And even with an ITM option you can still get several times the leverage of just buying (or shorting) the underlying.
All option sellers will blowup if they continue to do so for many years. Sh*t happens, and the deep OTM they thought it would never get into the money, will. The small premium received does not compensate the vast loss suffered.
Are you saying that one should just BUY OTM options for years and eventually will make it big then? I know you must be a troll then, because no one can be that dumb, not years and 3000 posts later
OTM disolve quicker than an ice cream cone on a 100 degree day...ATM disolve less quicker...there are many beginner option sites that share this...best studying/learning to you...