Which is better

Discussion in 'Options' started by MarketMonk, Oct 10, 2009.

  1. Looking back at last March, which of the two ways to invest with options would have been better?

    1) Buying a long dated ITM call?


    2) Buying a deep long dated OTM call?

    I am thinking of 6 month or longer options to have been purchased this last March.

    As I see it the advantage of the ITM call is that it will go up $ for $ once you are above the strike price.

    As for the OTM call, it would have been a higher strike, but cheaper in price. You could buy more contracts but at a greater risk.

    What are the other advantages/disadvantages?
    What are the risks that one needed to weigh at that time?

  2. MM, that is a pretty ambiguous questions, but I will take a stab. Althought Im guessing at what you meant by deep ITM vs way OTM. Lets assume you had you could buy 1 dec 2009 500 calls on Mar 2nd. Option two, you spend the same amount of money on Dec 900s.

    The Dec 500's are a 77 delta and closed for about 228.00. That means the buying power cost is about 22,800.

    The Dec 900's are a 23 delta and closed for 25.30. 228/25.3=9.01 Thus we buy 9, 900 calls.

    Today the Dec 500's are worth about 568, so you would have made 568-228=440 440*100=44k, thats a nice profit.

    The Dec 900s are about 174.30. So 174.30-25.3=149.00 149*9=1341, or 134,100.00. In this case the 900s were better.

    What is the lesson here? That the OTM calls are alway better? No, the lesson is that in a fast moving market, if you are right, the OTM's will out perform. If the SPX was sitting around 900, right now instead of 1065, the 500 calls would have been a far better purchase.


    Mark S.

  3. I think you are asking which one would give you higher return percent wise hindsight. Short answer would be go for OTM calls.

    Try use options lab's Offline tab to calculate this , which can go back in time.

    The site is: http://www.TheOptionsLab.com
  4. If you anticipate a market that's near the bottom - and I assume that's why you would be buying calls;

    And if you understand that when the market reverses direction, the then current sky-high IV would come crashing down;

    Then buying long-term options is the wrong way to go. You would lose a large amount of money due to the volatility crush.

    In this case, the market moved up more than 50% - and that was enough to offset the loss due to that IV decline.

    But, I assume you would not have been looking for a rally that large, or that you would still be holding onto those longer-term options. Most of the time you will not fare well when buying options that are vega-rich - when IV is at a 22 year high.

  5. spindr0


    You've sort of answered your own question. It's a risk vs reward comparison.

    With an equal dollar investment:

    - ITM call will give you profits on small moves and manageable losses on no move or down.

    - OTM gives you leverage so a large move can give you a much, much larger gain but no move or down will have a higher probability of a total loss
  6. Option911 -
    Mark, I get what you are saying.

    ramatrade -
    thanks for the link to optionslab. I am aware of and am starting to learn Samaosky's Options Oracle.

    dagnyt -
    Mark, I was not aware that call options would have a high IV when the market is crashing. I was under the impression that the IV drops on the side that is decreasing in premium (ie puts in a rising market and calls in a declining market). I will have to research this some more. Thanks for pointing this out.

    spindr0 -
    Yes I can see that. Now I am trying to figure out if one can quantify the risk/reward ratio between these two possible selections.

    I appreciate the responses.
  7. spindr0


    If you have a modeling program that can plot multiple time graphs prior to expiration, you can see the R/R via pretty pictures.

    Set up an equi-dollar spread. For example, if the ITM is $10, short 4 $2.50 OTM's against one of them (or vice versa). The graphs will show at what prices and time each position is stronger.

    For a more global approach (for expiration results), set up a spreadsheet with as many option series as you want and let a formula do the heavy lifting.

    Or buy a program that will do what you can do but don't want to do :)