I keep hearing from people that “DITM options are the same as stock”. While this statement is true with respect to the two parameters of “extrinsic value” and “delta”, DITM options have an incredibly different risk profile than stock and can be extremely useful tools. In this post, I’ll demonstrate this. Or rather, I’ll show you how you how you can prove this for yourself.
Make a spreadsheet. Create these columns:
Strike
Underlying price
Time premium / Extrinsic value (per share)
Intrinsic value (per share)
Option price (total $ cost of option)
Absolute risk (total $ at risk)
Delta (Position price change per dollor change in underlying)
Max reward
Reward for $1 positive move
Reward for $5 positive move
Reward for $10 positive move
Reward for $20 positive move
Reward for $30 positive move
Reward for $50 positive move
Reward for $100 positive move
Reward for $200 positive move
Loss for $1 negative move
Loss for $5 negative move
Loss for $10 negative move
Loss for $20 negative move
Loss for $30 negative move
Loss for $50 negative move
Loss for $100 negative move
IMPORTANT: DITM options will have a wide bid/ask spread and this may well be part of the reason inexperienced traders will not ever trade them. However, you can ignore that because you can place a limit order and get filled at or near the mid. To determine the price you will likely get filled at, simply look at the corresponding put and use that ask price. Example: for a $100 stock, the $60 strike put will likely by $0 bid, $0.05 ask (“Zero bid at five cents). Then take the intrinsic value of the $60 call (which is $40) and add $0.05. You will likely be filled at $40.05. Of course you cannot use a market order! You would place a limit order to buy at $40.05
You can use this for any stock. For now, for all values of “Underlying Price” write: 100
Now fill in the blanks for strike prices: 50, 60, 70, 80, 90
Now do the exercise again, but instead of strike prices, show the usage of margin:
2:1
3:1
4:1
5:1
What happens to “Absolute Risk”?
How does the reward compare to your absolute risk for these different instruments? (DITM vs. stock vs. stock-with-leverage-through-margin)?
