In a recent article, you wrote: "Way out of the money options are best used for installing up side protection on short position." Would you please explain this in greater detail? I am interested in trading options, but am still in the learning process. Thanking you in advance, D.C.I consistently try to convey that the great thing about options is their flexibility, because few rules are written in stone and there is really no one right way of doing things, so I was somewhat surprised to see I had made such a blanket statement. I looked at the
Too often, investors buy out-of-the-money options simply because they have a lower absolute cost than those that are in-the-money. One of the most common complaints of individuals who buy options is that the options "don't work" when they experience a situation in which the buyer accurately predicted the direction and even the magnitude of movement in the underlying share price, but the option's value barely changed. Way out-of the-money options are best used for:Let me expand on No. 4. Buying cheap calls is a great alternative to using a stop-loss order. This is especially true, as the statement above suggests, when establishing a short position in highflying, momentum-driven, heavily-shorted or hard-to-borrow stocks, as well as in anticipation of a price-moving event such as earnings. (These situations are prone to having an initial dramatic spike that takes out all the existing stop orders resting at the obvious resistance levels.) We've all felt the pain of being stopped out at the high and then watching the stock retreat after the initial overreaction. For recent examples, look at Apple's ( AAPL) earnings report or the action in Travelzoo ( TZOO).
long-dated expirations that allow time for the predicted price move to occur; very high-beta stocks whose price can undergo double-digit percentage changes on any given day; employing "what if" insurance in case of a catastrophe; and installing upside protection on a short position in case of a potential melt-up resulting from a short squeeze, favorable ruling or other parabolic-inducing influences.