Why you should never Buy Deep In The Money options?
Why you should never Buy Deep In The Money options?
Before we get started, let’s see what are the different types of option contracts available. Based on where the price of a stock is trading at, there are 3 types of option contracts available.
- In The Money option (ITM)
- At The Money option (ATM)
- Out of The Money option (OTM)
Let’s see each type in detail.
In The Money option (ITM)
A Call option is called In The Money, if the strike price of the option is less than the current spot price.
A Put option is called In The Money, if the strike price of the option is greater than the current spot price.
Why you should never Buy Deep In The Money options?
There are 2 reasons:
- You will need higher capital for trading, so it eliminates leverage advantage provided by options.
- Deep In The Money option increases risk but generates same returns as that of In The Money option
So it doesn’t make any sense to buy Deep In The Money option for any trader and better to stick it In The Money option.
At The Money option (ATM)
A Call option is called At The Money, if the strike price of the option is closest to the current spot price.
A Put option is called At The Money, if the strike price of the option is closest to the current spot price.
At the Money option is the most actively traded instrument in the market.
Out of The Money option (OTM)
A Call option is called Out of The Money, if the strike price of the option is greater than the current spot price.
A Put option is called Out of The Money, if the strike price of the option is less than the current spot price.
Out of The Money option doesn’t have any intrinsic value and it only has time value. So if you consider this option expires right now, it will become 0.
Capital required for trading Out of The Money option is very low when compared to ATM & ITM options.
Out of The Money option are generally called Hero or Zero Trades. [i.e] There are the option multibaggers, which generates 2X, 3X, 4X & 5X returns of the capital.
Hope this post helps you to understand different types of option contracts and why you should never Buy Deep In The Money options.
Please feel free to ask if you have any queries.
To learn in detail, watch our video: