If Intrinsic Value = Option Price Why Buy OTM?

[El OchoCinco]

Why would anyone buy OTM options when they could buy ITM options where the intrinsic value is basically equal to the price of the option? It seems to me like betting solely on extrinsic value via OTM is a bad idea...giving something for nothing in hopes it turns into something. Where does time value factor in to your trading strategy?

And i know i am a noob-ass on an "elite" trading site asking rudimentary questions but please help a brother out. I do appreciate the help.

Define OTM. A $105 OCT Call with the stock trading at $98 is OTM. So is the $180 OCT Call but they are not the same. Also in spreads one leg might be long OTM. Too simple to just ask about OTM without more meat on the bone to support it.

Get a book, sit back and read because the questions are being built on a lack of the fundamentals which is easy to correct.

 

[ironchef]

Why would anyone buy OTM options when they could buy ITM options where the intrinsic value is basically equal to the price of the option? It seems to me like betting solely on extrinsic value via OTM is a bad idea...giving something for nothing in hopes it turns into something. Where does time value factor in to your trading strategy?

And i know i am a noob-ass on an "elite" trading site asking rudimentary questions but please help a brother out. I do appreciate the help.

It is all probability based. In the example you posted, if you look at the delta of a strike (approximate probability of stock above that value), the delta of ITM strike of $17.5 has a delta of 0.956, meaning there is a ~95.6% probability stock price will be above that at expiration. For OTM strike of $21, the delta is 0.141 or ~14% the stock will be at or above that at expiration.

In general I buy ITM if the cost (extrinsic value) is less than buying on margins (margin interest cost through expiration). OTM, is more like buying lottery.

Please buy a book on options & study it if you are serious about learning options.

 

[El OchoCinco]

It is all probability based. In the example you posted, if you look at the delta of a strike (approximate probability of stock above that value), the delta of ITM strike of $17.5 has a delta of 0.956, meaning there is a ~95.6% probability stock price will be above that at expiration. For OTM strike of $21, the delta is 0.141 or ~14% the stock will be at or above that at expiration.

In general I buy ITM if the cost (extrinsic value) is less than buying on margins (margin interest cost through expiration). OTM, is more like buying lottery.

Please buy a book on options & study it if you are serious about learning options.

Why is OTM like buying a lottery ticket? No one said Deep OTM.

/ES is at 3017 the 3020 Call is OTM or if you want to technically call that ATM then the 3025 Call is OTM. Not really a lottery ticket if you expect market to go higher. Now the 4000 Call ...that is a lottery ticket.

 

[zghorner]

No insult taken from anyone saying that i should get a book on options, I know i am a beginner. Can any of you recommend specific titles i should check out?

The example i posted is basically the criteria i was asking about. Specifically when intrinsic value is very close to the price of the option. I just didnt see why you would buy OTM even slightly if you could buy ITM where most of the price paid via option purchase is Intrinsic...I as usual over complicated it and the answer seems obvious now.

This is another example of what i was thinking:
- underlying trading for $10
- $9 Call Costs $1.02, Delta 0.95
- $11 Call Costs $0.10, Delta 0.1
- You have basically only paid $0.02 for the $9 Call (considering $1 is intrinsic) which a much higher probability of it expiring ITM.
- You paid $0.10 for the $11 call with much lower probability of it expiring ITM.

- The OTM call isnt really cheaper if you put it this way, however, and the answer to my question is: yes it is obviously cheaper...because it costs less money lol. You can buy 10x the amount of $11 calls than you can $9 calls. It assums more risk but would come with greater reward on a $ for $ basis.

 

[gaussian]

No insult taken from anyone saying that i should get a book on options, I know i am a beginner. Can any of you recommend specific titles i should check out?

You don't need a book really. If you want theoretical knowledge you can look into Natenburg. There are a handful of options books on volatility trading, models, etc.

To get started you really just need to head over to OCC and do their educational program. Anyone telling you to get a book probably doesnt have the answer you need anyway - it's a common trope among people who want to hear themselves talk.

If I was going to start again I'd stick to OCC's stuff, learn what I can, play in the markets (WITH REAL MONEY!!!!) and then expand out to other books as I needed the info. I went way too deep before even trying in the market and ended up wasting a lot of time.

 

[taowave]

You have a decent understanding,certainly enough to make yourself dangerous

Following up on your example,if I forced you to trade the 9/11 ratio vs backspread,which would you choose??

You can either be

Long 1 9 call and short 10 of the 11 strike for a .02 debit

or

Short 1 9 call and long 10 of the 11 strike for a .02 credit

No insult taken from anyone saying that i should get a book on options, I know i am a beginner. Can any of you recommend specific titles i should check out?

The example i posted is basically the criteria i was asking about. Specifically when intrinsic value is very close to the price of the option. I just didnt see why you would buy OTM even slightly if you could buy ITM where most of the price paid via option purchase is Intrinsic...I as usual over complicated it and the answer seems obvious now.

This is another example of what i was thinking:
- underlying trading for $10
- $9 Call Costs $1.02, Delta 0.95
- $11 Call Costs $0.10, Delta 0.1
- You have basically only paid $0.02 for the $9 Call (considering $1 is intrinsic) which a much higher probability of it expiring ITM.
- You paid $0.10 for the $11 call with much lower probability of it expiring ITM.

- The OTM call isnt really cheaper if you put it this way, however, and the answer to my question is: yes it is obviously cheaper...because it costs less money lol. You can buy 10x the amount of $11 calls than you can $9 calls. It assums more risk but would come with greater reward on a $ for $ basis.

 

[zghorner]

You have a decent understanding,certainly enough to make yourself dangerous

Following up on your example,if I forced you to trade the 9/11 ratio vs backspread,which would you choose??

You can either be

Long 1 9 call and short 10 of the 11 strike for a .02 debit

or

Short 1 9 call and long 10 of the 11 strike for a .02 credit

So let me type out my reasoning on this question, thanks for asking it by the way I need all of this type of stuff i can get.

Long one $9 call ($1.02) = $102 AND Short ten $11 call ($0.02) = $20

or

Short one $9 call ($1.02) = $102 AND Long ten $11 call ($0.02) = $20

Without a doubt (at least from the perspective of someone with a fair amount of ignorance), The second option looks to be the obvious winner. You collect the $102 in premium which more than covers your long position AND in doing so you set a defined risk limit on the position.

Yes?

 

[taowave]

Im using your prices..

The 11 calls are trading at ($0.10),not ($0.02)...

Lets just say the spreads trade for even money...

I think you will find most traders that haven't gone the way of the dinosaur would choose the second option...Limited risk(max loss if stock is unchanged) and unlimited upside...

With that said,I am not saying its a no brainer to buy 10 of the 11 strike vs 1 of the 9 strike

So let me type out my reasoning on this question, thanks for asking it by the way I need all of this type of stuff i can get.

Long one $9 call ($1.02) = $102 AND Short ten $11 call ($0.02) = $20

or

Short one $9 call ($1.02) = $102 AND Long ten $11 call ($0.02) = $20

Without a doubt (at least from the perspective of someone with a fair amount of ignorance), The second option looks to be the obvious winner. You collect the $102 in premium which more than covers your long position AND in doing so you set a defined risk limit on the position.

Yes?

 

[zghorner]

Im using your prices..

The 11 calls are trading at ($0.10),not ($0.02)...

Lets just say the spreads trade for even money...

I think you will find most traders that haven't gone the way of the dinosaur would choose the second option...Limited risk(max loss if stock is unchanged) and unlimited upside...

With that said,I am not saying its a no brainer to buy 10 of the 11 strike vs 1 of the 9 strike

damn i did get the price wrong, i glanced at my original post and saw the $0.02 and went with it.

let me look at it again with that corrected.

Long one $9 call ($1.02) = $102 AND Short ten $11 call ($0.10) = $100

or

Short one $9 call ($1.02) = $102 AND Long ten $11 call ($0.10) = $100

I have to agree with you on the second option due to higher profit potential with less risk...but i cant say i would have seen that so easily without your pointing it out.

 

[ironchef]

Why is OTM like buying a lottery ticket? No one said Deep OTM.

/ES is at 3017 the 3020 Call is OTM or if you want to technically call that ATM then the 3025 Call is OTM. Not really a lottery ticket if you expect market to go higher. Now the 4000 Call ...that is a lottery ticket.

Points well taken.