Deep ITM calls

[chroniclenyc]

I have never done this myself, but the obvious benefit to me other than you don't tie up all of your capital is the asymmetrical payoffs for an ITM call option.

What I mean is that a move upward in the underlying will result in the option gaining more than it would lose from a symmetry move downward of the underlying. This is because your time-value is increasing as you approach ATM in a bell-curve like fashion. Moreover, if you have a call option, a fall in value of the underlying will also increase the time-value of the option due to positive vega since a fall usually results in an increase in expected future volatility. This gives you extra protection on the downside.

The negatives are theta working against you for the small amount of time value you have and the wide bid-ask spreads. Plus, you need to be on top of all of these relationships.

 

[Don87109]

Quote from Cereal:

These are two PAPER trades I opened yesterday and today just to do some testing buying deep ITM CALLS which have:

DELTA practically = 1
Extrinsic Value between 0 and 0.13

1) Bought one SLV MAR13 $14 Call for 19.20 (stock was at 33.21)

2) Bought one SLV JAN13 $19 Call for 14.35 (stock was at 33.22)

I'm no expert but wanted to try this because of the current uptrend in Silver and the DELTA which already a few hours after opening the trade has made them profitable.

Of course buying deep ITM calls means putting much more money at risk in premium.

As always any comments are appreciated. Thanks.

Usually it's better to buy an OTM Put and buy the stock instead of buying an ITM Call. At the same strike the position is equivalent and OTM Puts usually are more liquid and have better B/A spreads. Of course, the drawback is that the cash outlay is greater and one more commission.

 

[FrankSlaughtery]

Quote from Don87109:

Usually it's better to buy an OTM Put and buy the stock instead of buying an ITM Call. At the same strike the position is equivalent and OTM Puts usually are more liquid and have better B/A spreads. Of course, the drawback is that the cash outlay is greater and one more commission.

be careful b/c puts are usually more expensive (e.g. higher iv) due to hedging

 

[Don87109]

Quote from FrankSlaughtery:

be careful b/c puts are usually more expensive (e.g. higher iv) due to hedging

If true I don't think that is a significant factor.

If it was significant you could arbitrage these synthetic calls against real calls and get a "free lunch".

 

[donnap]

Quote from Don87109:

Usually it's better to buy an OTM Put and buy the stock instead of buying an ITM Call. At the same strike the position is equivalent and OTM Puts usually are more liquid and have better B/A spreads. Of course, the drawback is that the cash outlay is greater and one more commission.

Don! Yes, the same argument can be made for the OTM CC vs. the ITM NP.

Cereal, it's not likely that you're going to get those prices. Who's going to sell you the March for below intrinsic value. Probably have to pay the high end to get in. Add .10-.20 to those prices.

And on the exit, likely more slippage on the ITM calls. (Unless you exercise out. ) Hence, Don's suggestion.

Compare the likely costs of these trades to UL at 50% margin. Not the same trade, but similar over a wide range.

Compare other hedging techniques to your idea or Don's. You may find that buying long term very OTM puts is not the best way to go, but that really depends on how you want to trade it.

I'd go with the UL/put trade in most situations.