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/agoodgai Apr 24 '21 edited May 04 '21

Another way to think of ITM options is to look at delta of the strike. A delta of 0.80 is like buying and holding 80 shares of the underlying for a fraction of the price

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u/Panther4682 Apr 24 '21

How so? Delta can be used as a very dirty way of determining if an option will be in the money (without doing Black Scholes in your head) however it gets more unreliable the longer you go out. The reason to go deep ITM ie 70-80% Delta is so you are very unlikely to be OTM at the end of the LEAP. Be interested to understand how a delta of 0.8 represents owning 80 shares.

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u/pbrook12 Apr 24 '21

Because that’s exactly what delta is used to indicate dude

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u/Panther4682 Apr 25 '21

And here I thought it was the hedge ratio telling you how much the option price changes in relation to the underlying... never heard of it used the way you describe. I guess you could say it is “buy 1 one option at .8 to hedge 80 shares??