Deep ITM calls

D

droid17

Hi all :)

I have been reading a book about buying deep ITM calls as an alternative to buying the stock. Basically It suggests buying as deep as you can with a delta over 90%.

The author argues that you are getting the same benefit of owning the stock with about half the cost. My questions are do you guys like this strategy? Second the author didn't really go into how far out you should buy these calls, what do you guys suggest is a decent time out?

Thanks,

Droid
 
I have not traded this myself, but I have also read a number of articles and book chapters (Lee Lowell) about DITM calls and it sounds good to me.
Interested to hear what some of the experienced traders have to say.
 
A deep ITM call is just like stock except for a hideous bid-ask gap and no liquidity outside of market makers who just take your order, take the opposite position in stock, and pocket their auto-profit.

In other words, it's just like the stock, only worse. I think a given trade would have to have a pretty damn good edge before the extra profit from maybe taking a bigger position would outweight those downsides.
 
Yep, bid/ask spreads are a major downside to DITM. You're talking at least $0.10 difference for semi-near term (1-3 months) and that's for the most liquid issues (MSFT, etc). Makes it tougher to turn a profit when you eat $25/contract each way.
 
I have used DITM calls with at least 6-9 months to expiration for longer term trend following. The downside, as noted by others, is the wide bid-ask spread, but if you catch a good trend then it's not a big issue.
 
Quote from droid17:

I have been reading a book about buying deep ITM calls as an alternative to buying the stock. Basically It suggests buying as deep as you can with a delta over 90%. The author argues that you are getting the same benefit of owning the stock with about half the cost. My questions are do you guys like this strategy?

Second the author didn't really go into how far out you should buy these calls, what do you guys suggest is a decent time out?
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I think authors should spend more time on getting the direction right and risk management. If you buy a 90 delta call, you have very similar risk to the immediate downside as with the underlying.

How far out you buy creates another problem. The further out you go, the lower the delta. If you want 90 delta ITM calls, that means going deeper ITM and higher premiums. Higher premiums means more money at risk.

What's a decent time out? If you spot short term moves then shorter term is better since with a lower cost, your ROI will be higher. If you need more time for your move to develop then you buy further out however, the trade off will be a lower ROI.
 
By buying ATM LEAPS, you get higher than 50 delta (like about 65 or so) and the bid/ask spread is satisfactory. That's one way to get better odds of success without getting gouged on the spread. The gamma is lower than near term options, though, so you won't see the kind of exponential growth you might enjoy in a shorter term option. Of course, you don't get explosive growth on a delta 90 option, either.
 
True, but unless you are trading a stock with some extreme short term volatility (such as a pharama company prior to FDA approval or some kind of news lawsuit), I don't think Vega normally experiences a huge movement over shorter time frames (the OP mentioned 5-10 day trading periods). To be honest, I never look at the effect of Vega when I play options...strictly delta/gamma/theta (but I also avoid things like pharama companies as well), perhaps that's an oversight on my part, but it's never really seemed to impact my trading (I normally hold options<3 months).
 
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