© 2020 TheStreet, Inc. All rights reserved. In other words, the $3,000 limit applies only if your total net loss for the year is over $3,000, after any capital gains have been added. The 65 call trades for $5.60 — 7 times more expensive. The delta represents the price change of the option in relation to a one-dollar move in the stock. He currently manages his own portfolio and writes an investment strategy column for TheStreet.com, and is featured regularly on CNBC and other cable news shows. Receive full access to our market insights, commentary, newsletters, breaking news alerts, and more. Thanks for your advice and strategies. If the net sum of gains and losses is no worse than $3,000, then you can claim all the losses in the current year. Since the term on the option is more than 90 days, the deep in the money options are either $85 or $70 since they are both two strike prices below the stock price. Lenny was selected as OverTime Magazine's 2006-2007 "Entrepreneur of the Year.". Far more often than not, in buying sound companies, the sell prices are hit long before the strike date. DOTM calls have more positive asymmetry versus the ones that are closer to the money. I came across your website because I was thinking of buying high-dividend stocks and selling deep-in-the-money covered calls with very long expiration dates (2017-2018). I buy deep in-the-money calls as an alternative to the outright purchase of common stock so that I can capture the bulk of a stock's move in a shorter time frame. This is why it’s the strategy at Options … I buy deep in-the-money calls as an alternative to the outright purchase of common stock so that I can capture the bulk of a stock's move in a shorter time frame. Forget straight puts and calls, the fact is that nearly 80 percent of those seemingly simple trades expire as worthless. As the delta approaches 100%, the option will perform just like the underlying asset, meaning buying a deep in the money call is basically like buying the underlying asset outright but at a discounted price. Also consider: buying the actual shares and buying deep otm protective puts is functionally the same but has different side effects compared to buying deep itm calls. The leverage these DITM calls provide is remarkable. If you get a big move downward, your max loss is the cost of the option, verses the entire stock price for owning long stock. Stock is trading at 16.91 with $1 increment strikes so any option with a strike of 15 or less would be deep in the money. As an example, John used a $100.00 stock and a call premium of $9.00. When implied volatility (IV) levels fall, it is the purchasers of at-the-money (ATM’s) and out-of-the-money (OTM’s) options that are hurt the … The Deep ITM approach . True, buying at-the-money or out-of-the-money calls requires less money, but that's the trap, because they offer less leverage. Call options give you the right, though not the obligation, to buy shares — usually 100 shares per options contract — by a specific day for a particular price. They are addicted to the thrill of the game as they continue to look for that next explosive trade. F or many people, the term options trading is synonymous with risk and potential catastrophic downsides. They are addicted to the thrill of the game as they continue to look for that next explosive trade. One way you can calculate intrinsic value is by subtracting the strike price from the underlying asset’s market value. Why? On Tuesday, this was the case with the August $42.50. Holding deep ITM calls (or puts) is like buying (or shorting) the underlying stock in a sense, as deep ITM options move point-for-point with their underlying. Making money trading stocks takes time, dedication, and hard work. The deep in the money call option strategy was the first option strategy that I used, when I got into options trading several years ago. Check out these eight reasons for why you should use this strategy: Deep in the money calls make the most sense when you see how they work in actual practice. Any investment is at your own risk. 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. price-to-earnings ratios. For a more detailed explanation of capital losses and the benefits of loss carryovers, please consult your income tax professional. I elected to roll the position into the November $40 Bank of America calls and book a loss to the Stat Book. Make Money By Spending Less. Instead of selling a standard credit call spread, let’s take a look at what happens when we sell a deep in-the-money (ITM) call spread. You can ignore the $3,000 limit on losses per year, because you have an overall net gain of $1,000, in this example. If the above deep in the money calls work and I am exercised from XOM Stock I have the potential to earn a total return of 3.78% for 4 months. Essentially, this is why deep-in-the-money options are a great strategy for long-term investors, especially compared to at-the-money and out-of-the-money options. It's important to remember that losses and gains must be combined together to determine whether you will have a net loss for the year. It makes more sense—instead of buying 500 shares of ABC stock at $60 (for $30,000)—to buy five of the ABC Jan 45 calls at $18.50 (for $9,250). Intrinsic value is an asset’s — in this case, an options contract’s — worth as determined either by an objective calculation or through financial modeling rather than using the current trade price of the associated underlying asset. Hi Lenny. Because 90% of traders who buy options without having an edge lose money. This means that for income tax purposes, the loss of $11,200 on the Bank of America $42.50 would really increase the cost basis of the November $40s that were purchased. Basically when you buy a deep in the money call option, you are buying the stock almost outright, a deep in the money call option is a stock replacement strategy, because the option moves almost 100% in correlation with the underlying’s stock move. This rarely happens, and there is not much benefit to doing this, so don’t get caught up in the formal definition of buying a call option. If this deep in the money calls trade could be repeated twice more during the next 8 months the realized return would be 11.34% for the year. Ten days later you buy 10 new contracts of Option A for $800. Also notice that these DOTM calls are much cheaper than the ones closer to the current stock price. With so many great reasons to implement this strategy, you’re just leaving profits on the table if you don’t give it a chance. However, the loss can be transferred to the cost basis of the like security item. Buying options is a lot like gambling at the casino. A call option is in the money (ITM) when the underlying security's current market price is higher than the call option's strike price. Call Options Definition: Call options are a type of security that give the owner the right to buy 100 shares of a stock or an index at a certain price by a certain date. You’re betting for a specific outcome with odds of winning a mere 25% to 40%! For trading covered calls, again in my personal opinion, there is no more effective methodology to trade covered calls than the BCI methodology…and I can assure you that I’ve reviewed (including reading EVERY book in print on covered calls), took training in, spent money on, and used just about every covered call system available. Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. Because 90% of traders who buy options without having an edge lose money. Almost all of my long calls are deep in the money (.7 - .9 delta). You purchase a call option for December at a strike price of $85 in July. Buying the Deep ITM call also keeps some risk off the table. So, if you are absolutely certain that the price of the underlying stock is going to move a lot and move quickly, then you will earn a higher percentage return trading these calls and puts than trading the stock itself. But you can add the disallowed $250 to the $800 price of the new contracts, producing a cost basis of $1,050 for the new contracts. : Are you Dutch? * ABC Jan 45 calls trading at $18.50 (These are in the money by three strike prices.) When implied volatility (IV) levels fall, it is the purchasers of at-the-money (ATM’s) and out-of-the-money (OTM’s) options that are hurt the worst, while the deep ITM options … If that interests you, it’s time to learn about buying deep in the money calls. Within two days of this move, the Bank of America November $40s closed out for a win. The intrinsic value is the difference between the option's strike price and the underlying security's current market price. Selling Deep In The Money Calls Example Let's say you like McMoRan Exploration (MMR, oil & gas company). Buying deep in-the-money (ITM) options is a good way of carrying out directional trading in high volatility market environments. You’re interested in making some income on a company through a deep in the money call option. The IRS describes an option as being “deep in the money” if it: Deep in the money calls differ from regular in the money calls in that the difference between the strike price and stock price must be greater than $10 or, in some cases, 10% of the overall cost. Has a term of fewer than 90 days and the strike price is one strike price lower than the highest available stock price. It’s a fool’s errand. In this variation, however, the trader simply substitutes a deep-in-the-money call option for the shares; everything else stays the same. Buying a “deep In-the-money” call means that you are purchasing a call with a strike price well below the current price of the stock. The red rectangle shows DOTM calls struck at $85 and $90. An option is said to be "deep in the money" if it is in the money by more than $10. For example, say you bought 10 contracts of Option A for $1,000 and sold them for $750, producing a $250 loss. Although it is a less expensive way to own the stock, there are at least two significant risks: (1) time decay will eat away at the value of your deep in the money calls as time passes, and (2) the stock could drop … Unlike its more popular cousin, the Covered Call, which is a bullish options strategy that makes its maximum profit when the stock moves upwards, the Deep In The Money Covered Call is a neutral / volatile options strategy which makes its maximum profit even when the stock remains stagnant or moves up / down.Yes, profiting in all 3 directions. Deep in the money calls are great for income generation and buy-write strategies. Consider deploying a deep in the money call strategy if you: Before you start buying up deep in the money call options, there are a couple of risks to consider: For most options traders, the advantages outweigh the disadvantages when it comes to deep in the money calls. The 90 call in this example trades for $.80. Buying options is a lot like gambling at the casino. Deep-In-The-Money. On the options contract, the specific day is known as the expiration date, and the price is known as the strike price. Deep in the money Covered Call is one of my favorite strategies as it is as close to an arbitrage as it can get. When a security is sold for a loss and a like purchase is made within 30 days of the sale, (either before or after the sale), a loss cannot be claimed on the losing position. For options, both a call and a put option can be in the money. Deep in the money calls work in much the same way as buying traditional stock. The figure below shows the risk graph of this trade. Deep in the money calls are low-risk, low-reward options contracts. Covered call writers, of course, have the option of taking the traditional path and buying 100 shares of the underlying security and selling a call against it. However, buying deep ITM options cost less than stock, allowing you to either leverage up or retain cash for other investments or to just earn interest. As the delta approaches 100%, the option will perform just like the underlying asset, meaning buying a deep in the money call is basically like buying the underlying asset outright but at a discounted price. One is whether to purchase an in-the-money ( ITM) or out-of-the-money (OTM) option.While the … Calls . This is the difference that made all the difference. Selling deep in-the-money (ITM) calls when they are pumped with time premium. When you sell the reacquired options, the adjusted basis will, depending on the sales price, produce a bigger loss to claim or reduce any taxable gains. Action Alerts PLUS is a registered trademark of TheStreet, Inc. More often than not, in buying sound companies, the good-till-canceled sell price will hit long before the strike date. At the time of publication, Dykstra was long BAC. Results may not be typical and may vary from person to person. There are a couple main reasons: First, by buying so far in the money I pay much less extrinsic value. Deep in the money calls work in much the same way as buying traditional stock. A three time All-Star as a ballplayer, Lenny now serves as president for several privately held businesses in Southern California. You’re betting for a specific outcome … Has a term of more than 90 days and the strike price is two strikes lower than the highest available stock price. When Should I Use a Deep in the Money Call? Deep In The Money Calls – Summary of XOM Stock Trade. When one compares downside protection with the upside rewards, I consider it comparable to the Mets playing a high school team. Wouldn't that be considered a wash sale? Nicknamed 'Nails' for his tough style of play, Lenny is a former Major League Baseball player for the 1986 World Champions, New York Mets and the 1993 National League Champions, Philadelphia Phillies. As for the statement "Buying deep in-the-money options is really not much different than buying stock on margin." This Trade: Note: To maintain a constant risk of approximately $1,000 the size was increased to 10 contracts. Before we begin… Did you know that most traders are always trying to score big… driven by the burning desire to hit it big. The strategy I implement with my deep in-the-money calls is to buy with a strike date four to seven months in the future in order to provide leverage and downside protection over a long period of time. Additionally, as the money gets deeper, the delta gets higher, meaning that the option should move in step with the underlying asset in terms of valuation up or down. The term “in the money” means the options contract has intrinsic value, or the assigned value, rather than the market value of its underlying asset. Value. Those are the sort of companies that will perform well using my strategy. I like the idea of using deep in-the-money calls to control roughly 100 shares of stock. The most obvious difference between the Deep In The Money Covered Call (Deep ITM Covered Call) and the regular covered call is the fact that out of the money call options are written in a regular covered call and deep in the money call options are written in Deep In The Money Covered Calls. Lenny explains his strategy and fields reader email. “There is less risk using deep in-the-money (ITM) long calls than buying stock and selling the corresponding short calls”. When an option is close to expiration, there are three choices investors can make: Exercise the option and purchase the stock, allow the option to expire, or sell or roll the option for a loss. When selecting the right option to buy, a trader has several choices to make. You really do have to sell calls against it though, and be careful of big moves upward near the time the short option expires. 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