Thread by @Quants_Capital

#ITM Vs #OTM #Options Which to #BUY?

When selecting the right #option to #buy, a #trader has several choices to make. One is whether to purchase an in-the-money (ITM) or out-of-the-money (OTM) option.

While the goal for "#vanilla" #buyers is to have the option be in the money at expiration, the selected option depends on the amount the trader wants to spend and their risk tolerance, as well as their specific expectations for the underlying stock.

UNDERSTANDING #ITM Vs #OTM

Before delving into the pros and cons of each, let's look at what it means to be itm or otm.
A #call is ITM when the underlying stock is trading above the strike price.
Conversely it is OTM when the underlying stock is trading below the strike price

A #put #options is ITM when underlying stock is trading below the strike price.
Conversely it is OTM put when underlying stock is trading above the stock price.

WHY BUY #ITM #OPTIONS?

Like all trades,ITM options have #risks and #rewards. These options are generally viewed as the more "conservative" choice, as they have higher #deltas : the measure of how much an options price will change based on the movement of an underlying stock :

meaning there's a better chance for the option to be in-the-money at the time of #expiration.

Buying ITM options also lessens the impact of #time #decay or #theta decay, as they carry both #intrinsic and #timevalue.

This means that even the if underlying value of a #stock remains static through a contract's #expiration, the trader can sell to close an ITM option and still collect the remaining intrinsic value, thus avoiding a total loss on the trade.

In-the-money contracts, however, are more expensive to enter than their out-of-the-money counterparts. And while the payoffs on an in-the-money trade can be high, the trader could ultimately suffer a bigger #loss if the underlying stock moves the #wrong way.

PROS AND CONS OF #OTM #OPTIONS

While out-of-the-money options are typically viewed as the more "aggressive" of the two, there are potential upsides to purchasing these types of contracts. For one, the cost to buy an OTM option is lower than the cost to buy an ITM option.

This is because at the time of the purchase, OTM #contracts have no #intrinsic value. So, while the potential for a 100% loss is greater, the cost (and risk) to enter the trade is lower.

In the same vein, buying an out-of-the-money contract can give the trader serious leverage,

if the underlying stock moves in his favor, since the initial cost is relatively low. While all options offer the benefit of leverage, the less money you spend, the more you stand to gain from this feature.

On the other hand, out-of-the-money contracts have #lower #deltas,

so the chances of the trade expiring in the money is slimmer. These contracts are more susceptible to #time #decay, too. This means that if the #underlying stock does not see a dramatic swing in the trader's favor, a 100% loss is likely to occur.

WHICH #OPTION SHOULD I BUY?

In conclusion, the choice between in-the-money and out-of-the-money options comes down to a matter of preference. Each alternative offers pros and cons, so it's up to you to decide which features are most appealing.

Plus, bear in mind that your choice may change with each #trading #opportunity. When you're forecasting a quick, drastic rise in the #underlying #stock, it might make more sense to buy out-of-the-money options.

Conversely, if you anticipate a relatively modest rise over a longer time frame, you may prefer to trade in-the-money options.

These are some of the thoughts on #buying of #options

#OptionsTrading #optiongreeks #weekendgyan #quantscapital

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