Why not always invest in Deep In The Money / Delta 1 Options?

surfer25 · Dec 10, 2015

OTM-Options said:
Covered Calls and Naked Puts are almost identical in terms of risk and reward. The risk of both is relatively substantial compared to the reward - I would not recommend them.
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Exactly my point.

ironchef · Dec 17, 2015

HappyTrader said:
So far I've seen ways to improve upon this, but none that really say : Here's a major downside.
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As someone else said, there is no free lunch. I found that most folks that long ditm calls were retail folks like us and our counter parties were market makers. I don't expect them to lose $ so somehow we are paying for it. Notice the IV of ditm are usually very high, sometimes 2x ATM. and then there is bid ask spread that will cost you dearly. The market is quite efficient and option pricing theory is well known so all the advantages/disadvantages are priced in. I did back testing on spy and yes, I got higher returns but also higher volatility (CAPM) so in down years the simulation did worse than the underlying. in fact you don't need simulation or CAPM to see that leverage will increase your risk so risk/return has no advantage. if you are willing to go long term your return will likely be higher than the underlying but you will have big whipsaw returns. Notice if you buy small caps and stay long term the returns will likely be better.

So you say OK in a down year you are no worse than holding the stocks because the rest of your $ is in risk free funds but don't forget if you only invest xx% in option and keep the rest in risk free $ your overall returns will be down because your returns on risk free is poor. To achieve better return, you have to go all in and in 2008 you would be wiped out. I don't know if I am making any sense?

That said there are ways to make it comes out positive but I have not found any foolproof ways yet.

Regards.

OptionsMocha · Dec 17, 2015

In my opion, deep ITM options have the same risk as owning the stock, but less liquidity, is subject to changes in IV, suffers time decay, and has large spreads.

If you want a delta of 1 why not buy 2 ATM calls? Theta will be greater, but you will have less risk in a rapid move against you due to gamma.

newwurldmn · Dec 18, 2015

HappyTrader said:
Deep In The Money (DITM) Call Options with a Delta 1 (or very close): Why not always do this instead of buying the stock directly?

There is the downside:
1) You own an option not stock, so no voting rights.
2) You likewise do not get dividends.
3) The contract price is too high (100x a position like BRK.A has rendered the number of options on them available as... none..)
4) If there are other perks (rare) in owning the stock, you don't get them.

But are there any other downsides? Because the upside:
1) At delta 1, if the stock goes up 1$ your option goes up 1$
2) If the stock drop below your strike price you've capped your loss
3) Since you are paying for an option, the price is going to be less than the stock itself: This translates to leverage.

For example, AMZN 20-JAN-17 Call @ 270 is trading at 251 (AMZNA201727000.U) with underlying price at 518.01 (at time of this writing).

This translate to a delta of 99.0990 and a leverage of 2.0452.

Or basically, you can own the equivalent of two times of stock for the price of one and in this case pay very little premium for the benefit of doing so. (Or expend half the amount of cash to control the same amount of stock).

As opposed to buying on margin, you don't have to worry about a margin call (or pay the interest rate).

If the stock crashes to below 251$ your option becomes worthless (but this is the same as buying the stock at 518$ and watching it drop to below 251$.) For example:

Buy Stock @ 518$, drops to 250$ = Paper Loss of 260$
Buy Option @ 251$, underlying drops to 250$ = Actual loss of 251$

However, since you only paid 251$, the difference (518-251) = 267$ could then be used to buy the stock at 250$ putting you at the same net position.

Of course if it drops even further you're saved by the maximum loss.

And if the underlying price goes up, you would profit at a 1:1 ratio (almost).

(And so far, I haven't discussed any of the additional benefits one could have from this strategy, such as hedging, writing calls, or investing the saved cash risk-free)

So then the question really comes down to:
Why not always buy stock options instead of the underlying position (except for the reasons listed above).
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Instead, buy the stock and buy the out of the money put. You get all the perks of stock ownership and the protection on the downside. You also pay less in bid/offer and have more liquidity if you really need it. You will get more relief from the broker as well. A $1 strike SPY call requires more margin than SPY shares even though the risks are almost exactly the same because options are not marginable in reg-t.

Visaria · Dec 18, 2015

better strategy might be to purchase out of the money call bull spreads instead of buying deep in the money calls.

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Why not always invest in Deep In The Money / Delta 1 Options?

surfer25

ironchef

OptionsMocha

newwurldmn

Visaria