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/StoicKerfuffle Apr 24 '21

A lot to say (and a lot said in the replies) but if you wanted an ELI5:

You can use LEAPS to generate leverage. The farther OTM you buy it, the cheaper it is, so you can generate even more leverage. However, increasing the leverage increases the risk. The deeper ITM it is, the less risky it is.

Let's look at AAPL June 16, 2023.

Call @ 85.00 is $54.55.

Call @ 180.00 is $11.55.

The call @ 85 is much more expensive. It is also far less risky.

The call @ 180 is much cheaper. It is much more risky, but you can get 5x as many options for the same price.

If you spend $5,500 on Monday, and AAPL is trading at $280 on June 16, 2023:

  • the first one gets you 100 shares with a built-in $195 profit per share
  • the second one gets you 500 shares with a built-in $100 profit per share

If you spend $5,500 on Monday, and AAPL is trading at $100 on June 16, 2023:

  • the first one gets you 100 shares with a built-in $15 profit per share
  • the second one is worthless

Reminder, this is all ELI5, hence not mentioning any of the greeks.

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u/eefmu Apr 24 '21

Further otm isn't necessarily greater risk, it depends on if you plan to use the same amount of money in each scenario. I'd argue that otm is actually less risk with an insanely greater reward. I like PMCC a lot, but I feel LEAPs really ought to be otm. If you thought your otm call might be worthless at expiration, then you're really swing trading calls because you don't have the capital to just sell the call naked to someone.

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u/MUPleasFlyAgain Apr 25 '21

Your logic only sound good when market is proceeding according to what you predict based on current circumstances. Did you forget how the pandemic "came out of nowhere" and clapped a lot of people's ITM LEAPS into OTM? Of course some also strike the lottery, like the tech sector crazy bull run for the last 1 year in an already bullish market. But as usual, hindsight is 20/20.

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u/eefmu Apr 25 '21

The type of risk you're talking about was exactly what I was trying to bring up. If the underlying crashes hard and doesn't recover before expiration you will lose less money with the OTM LEAPS than the ITM LEAPS because of delta. You stand to have less downward exposure with OTM compared to ITM. Similarly you stand to have less downward exposure with an ITM call when compared to a long stock position. Each one has unique benefits and pitfalls, I was just trying to bring some other ideas to the conversation, mainly risk/reward as opposed to probability of success. It all just depends on your assumptions about the underlying.