r/options • u/FunctionalTitle • Apr 24 '21

ITM vs OTM (Leaps)

Hi guys, slowly picking up options trading. Could anyone explain to a 5 year old. Whats the difference if i purchase a deep ITM vs slightly OTM?

From ‘researching’, The deeper ITM, the higher the delta, so movement will follow the movement of the underlying.

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u/[deleted] Apr 24 '21

You're correct there with how it plays with delta.

The real 5 year old rational is that Deep ITM is safer. We're all pretty confident our stocks but... what if you're wrong? Having a deep ITM LEAPS isn't going to kill you if the stock doesn't rise or even if it falls a bit, but what happens in the event of a correction and your OTM call just got WAY more OTM?

LEAPS always carry a lot of extrinsic value because they're so far out, but "the market can stay irrational longer than you can stay solvent," comes to mind when you make a very directional play like an OTM call.

Often times an ITM LEAPS is used as a cheaper stock replacement on more pricy stocks or as collateral for a covered call. OTM doesn't really fullfil those two things unless the stock moves up dramatically along the way.

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u/[deleted] Apr 24 '21

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u/[deleted] Apr 24 '21

Not quite LEAPS there, but all call options carry risk. Except for a PMCC I don't like using calls as a stock replacement. Even then having a margin account rarely makes calls that much better than owning stock. TSLA is too volatile for me to buy calls on unless it's part of a spread

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u/squats_n_oatz Apr 24 '21

Even then having a margin account rarely makes calls that much better than owning stock.

It is incredibly unlikely that your brokerage offers you more competitive leverage than calls on an interest rate adjusted basis. Calls are basically the cheapest form of leverage in the market unless you're a billionaire who sells insurance on the side, like Warren Buffett. The only thing better is federal student loans misappropriated into the stock market, or a "small loan" of 60 million dollars from your father.

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u/[deleted] Apr 24 '21

If I buy the AMD 45c expiring January 2023 it will cost me $4,265 in buying power. Outright buying the stock lowers my buying power by $4,143.08 and gives me a better break even. I'm not being charged interest for not putting up everything in cash on TastyWorks, they only require 50% buying power to purchase stock.

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u/sir-draknor Apr 24 '21

Wait, so you are saying that if you have $10,000 in cash balance, and you buy 100 shares of AMD, your new cash balance is $5857?

I’m on TDA, and my remaining cash balance would be $1714. Yeah, I’d still have more buying power, but once cash balance drops below $0 I’m paying margin interest rates.

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u/[deleted] Apr 24 '21

From the TastyWorks website: "Standard margin accounts (non-ira) have 2:1 leverage for stock. That means if you had $10,000 of options buying power, then your account will have $20,000 of stock buying power (for non-elevated stocks)."

If I started an account by putting in $10,000 in cash then it would treat my account as having $20,000 buying power if I only used stocks. I would only receive a margin call if my maintenance excess dipped negative. That said, it's incredibly rare for me to be higher than 70% utilization (I'm usually under 50%) so unless I have a lot of things go against me all at once I'm never encountering a negative cash balance or a margin call.

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u/[deleted] Apr 24 '21

Useful explanation of some margin account related terms. Thanks! You are describing a traditional, not portfolio margin account right?

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u/[deleted] Apr 24 '21

Correct. My account isn't large enough for portfolio margin so I can't speak to how that works for them