Why doesn't everyone buy the lowest strike-price call option?
Novice here, apologies for the stupid question.
Let's say that a given stock (e.g. NVIDIA) is trading at 675. If you buy a call option, then you believe the stock is going to go up.
Currrently, call options on NVIDIA trade roughly at (Strike Price / Cost) of (650 / 50), (670 / 40), (700 / 25).
If I want to minimize Strike Price + Cost, why doesn't everyone just buy the 650 / 50 option? Wouldn't that give me the maximum profit?
Think what happens if it goes to 665
Right, but if you buy a call option, then you believe the stock is going to go up, yes? Why would you consider the case when the stock goes down, if you believe it's going to go up?
No matter how strong your view and thesis are, you can't just ignore the possibility of an adverse price movement
If it goes to 665, and I take the 650/50 option, then I'm down 50-15=35 dollars (I have a share worth 665, that I've bought for 650).
If it goes to 665, and I take the 670/40 option, then I'm down 40+5=45 dollars (I have a share worth 665, that I've bought for 670).
So again, the 650/50 option is worth it. Why doesn't everyone buy that option, then?
1) there’s deeper ITM calls than $650. Typically goes all the way down to like $50 for strikes, although those really deep ones are mostly illiquid and not traded. Still, the point stands. You could go pickup a $500 call right now for example.
2) sometimes it doesn’t make sense to buy certain calls. For a stock like NVDA, IV is super high right now with options pricing in a huge move on a $2T company, which doesn’t happen often. Also, if everybody moves into a specific option because it’s underpriced, it suddenly becomes fair priced or even overpriced due to this new buying pressure.
3) just because the 650 call has better downside protection than a 670 call doesn’t make it a good buy. It’s obvious it would be “better” than the 670 for downside because it’s further ITM and more expensive. You would buy the 650 call if you thought it was the maximally efficient way to build your position given a certain anticipated move, and taking into account the probability that the stock moves like you anticipate
If you’re trading the deeply ITM call, 1) spread is huge down there. You can reduce some of it by buying a put and a forward. 2) Why are you buying the option if it behaves like a forward (delta 1)? Optionality has value around ATM.
Many books on this out there. John Hull wrote them for a reason. To start options have leverage, buying options is not free, tying up capital is not free. There is a reason skew exists.
Anyways, ITM options are mainly instruments to use for yield hedges and to do with the margin cost of holding a position.
Lastly, the example someone gave you to start was not direct enough. The real question is what if the stock goes to $600, are you going to exercise?
Quae voluptas temporibus illo deleniti deleniti. Adipisci et voluptatem ducimus optio. Consequatur accusamus perspiciatis quo velit sed reiciendis.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...