How to evaluate LEAPS and Deep OTM options?

[ironchef]

So you’d break-event at $245 and get 275% ROI at $300.
While if you buy $215/$225 call spread for $3 then you’ll break-even at $218 and get 230% ROI at and above $225.
Both are valid bets and calls may actually work better during temporary swings.
I guess the OP just wants to be able to come up with some metrics to plan and estimate his bet.

I like your suggestion. You have a higher probability of making 230% than @newwurldmn's 275%.

 

[Matt_ORATS]

How do you evaluate OTM call options? Everything I have read only teaches about ITM

Is there some resource out there that will teach me how to buy OTM calls?

I’m getting really frustrated. All the books I’ve bought and in everything I’m reading to learn no one teaches this.

They all teach how to evaluate and buy ITM options.

I’m a value investor (with a GARP/growth at a reasonable price focus).

Most of the really high volume, popular, and high flying stocks that people trade options on don’t fit what I’m looking for.

I want to buy OTM call options and LEAPS 7 to 8 months (or more) out on undervalued stocks and hold them for two to three Quarters/earnings calls.

On the stocks I’m looking at the volume and open interest is low. The spreads are wide (more like huge) and the delta and gamma on most is low.

So far the stocks I want to buy options on the delta is no more than 25 or 30. The Gamma for most is 3 to 5.

How can I evaluate an OTM call to see if it’s worth buying? What numbers/metrics should I focus on?

I would start by setting up a backtest on stocks that you have liked in the past and observe which options strategies performed best.
In our backtester you can put in dates for entries and exits for multiple symbols.
You can test things like:

• Days to expiration 180, 225, 300
• Deltas 20, 30, 40, 50
• Only buy a call when the 6 month IV / 120 day historical volatility is < 1.0
• Only buy a call when the long term put/call skew percentile < 50
• Only buy a call when the bid-ask spread < 1% of the strike price
• Exit the call after holding for 180 days

If you are interested, I can show you how to do this. We also offer consulting where we might run thousands of tests with your objectives in focus.

I ran a couple of tests on MSFT since 2007: One was a 30 delta, 225 day; the other was a 20 delta, 225 day, exiting after holding 180 days.