Dykstra: Going Deep

In and Out of the Money

The strike price, or exercise price, of an option determines whether that contract is in the money, at the money, or out of the money. If the strike price of a call option is less than the current market price of the underlying security, the call is said to be in the money; the holder of this call has the right to buy the stock at a price that is lower than the price he would have to pay to buy the stock in the open market.

As I have made clear over the last several months in my columns, when it comes to options, we will not be recommending anything but in-the-money calls.

The beauty of in-the-money calls is the leverage they provide, which allows you to control a stock with significantly less money at risk vs. a cash or (certainly) margin purchase for that same stock. Your risk is limited to the cost of the in-the-money call, compared with buying the stock with cash or on margin, which is a very dangerous game that I strongly suggest you avoid playing.

If you're just beginning, make sure you buy deep-in-the-money calls at least four to six months away from your strike price. If you get the anticipated move, your in-the-money call will capture more of the move. If the stock moves against you, the longer-term option has more time to recover.

My strategy for in-the-money calls is to employ them when companies with solid fundamentals are being (in my eyes) overly punished on Wall Street for one "transgression" or another. My theory is that this overreaction will eventually correct itself as the value of the company reasserts itself over time; those who buy deep in-the-money-calls in advance of this correction will be rewarded.

Remember, it takes only one or two bounces, or spikes, in the stock for you to make a profit. But you must act! Options can be very volatile, so if you want to be a winning trader, you need to stay on top of your open positions. Remember, if you don't have the time to watch your stocks all day, you can always put a good-till-canceled (GTC) limit order in to capture the profit you are satisfied with. Don't be greedy, a win is a win, especially in options, because you always have time working against you.