When to Opt for In-the-Money Plays

How or why do we want to buy a call that is already well in the money, where the option has no trading volume or any open interest?

Regards,
Henry

One of the more difficult parts of option investing is trying to figure out which option is the best choice among the literally hundreds of options listed for any particular stock. There is nothing more frustrating than making a correct prediction on a stock's movement, only to fail to reap the appropriate profit because the option strategy employed didn't produce the expected results.

The experience of an option not "working" probably discourages more people from trading options than any lack of understanding about options concepts. Having a basic knowledge of how different options and strategies perform under various scenarios and applying a few basic rules of thumb can help aid the decision-making process, but the wisest course is employing the most straightforward and simplest strategy.

And because the most common type of trade is based on an expectation of the direction of the price of a particular stock or even the overall market, the simple purchase of puts (a bearish bet) or calls (a bullish bet) is the most effective approach. Unfortunately, individual investors have a tendency to buy short-term out-of-the-money options.

"The most common mistake among retail investors is turning a fundamentally, or technically, sound prediction into a purely speculative proposition because they choose to buy low-cost options," says Adam Nevin, head of derivative trading at NVR Capital. Nevin explains that many investors mistakenly confuse an option's cost in absolute dollar basis with whether it is "cheap" or "expensive" on a relative basis.

An out-of-the-money call, even with a low cost of 20 cents, can actually be quite expensive when implied volatility and time remaining are included in calculating the probability of the option increasing in value.

The general rule of thumb when buying options is to make a directional bet either at-the-money or one strike in-the-money, and have at least 60 days remaining until expiration. The two primary reasons for using a longer-dated option are that it allows a reasonable time for the investment thesis to play out and it minimizes the initial impact of time decay eroding the option's value.