# If you're betting on an extreme price movement, ought you buy OTM or ITM options?

1. Please see the titled question.

2. This Reddit comment asks a related question.

So does going deep ITM reduces the risk but also reduces the return on the investment in case the stock spikes up? Since even though the delta is higher, the premium is also higher by a lot?

Sort of. I definitely view it as a safer, lower risk/lower reward bet.

An OTM LEAP (like the 120c cited above) has a delta of 0.56 whereas my LEAP has a delta of around 0.80. Meaning if AAPL slowly crawls up towards the ATH it hit a couple weeks ago, the deep ITM LEAP will make more than the OTM LEAP. The advantage there is you could also elect not to hold to expiration and the ITM LEAP will be more profitable.

You pay more upfront for the intrinsic value on the ITM, but you get that intrinsic value back when you sell the LEAP or get assigned the shares. Let's take the exact example as the 120c above. The 80c costs \$41.50 right now while the 120c costs \$23.00. If AAPL hits \$130 at expiration like the person above postulated, the deep ITM leap would net you around \$900 in profit while the 120c wouldn't break even until \\$140 per share.

Final Bonus: With the deep ITM LEAP you can set up a PMCC [Poor Man Covered Call] by selling weekly Covered Calls against it. I like a 0.20 delta strike so that even if AAPL pops the whole spread makes money. And each week I'm collecting premium for the calls to lower my cost basis.

OTM. If you buy deep ITM calls, your delta is 1. You will essentially own the stock with no leverage. With deep OTM calls, you will have gamma working for you. Your delta will increase as the stock rallies and are highly leveraged to the movement of the stock.

The answer depends on the size of the move, when the move occurs (soon or closer to expiration), and whether it's a fixed dollar bet or not. Let's assume a fixed amount and you buy as many options as you can at each strike.

An expiration calculation is easy. Assume it's calls with an extreme up move in share price to "X".

• Pick a dollar amount for your bet.

• Cut and paste the strikes and option prices into a spreadsheet.

• Determine how many of each strike put you could buy with your starting capital

• Assume that all ITM strikes go to parity and will be worth their intrinsic value ("X" - strike) x number of puts. Subtract the position's cost and that's your gain. Now compare the gains (or losses) at all of the respective strikes. That's your winner. Unfortunately, this is only known in hindsight because this ideal performance is based on knowing how high the underlying is going to rise.

An evaluation involving value prior to expiration (time premium considerations) and change in IV would require an imbedded option pricing model calculation and that's a far more complex spreadsheet.

There are software programs such as Optionvue which can tell you how a position (or multiple positions) will perform at any price, at any implied volatility, on any day prior to expiration. Sweet! Just input the future date and price and download current quotes and VOILA! Such programs have the same fallibility as the spreadsheet because they too require knowing how high the underlying will rise and when. Geez, if I knew that, I'd be rich.

Many, many years ago (decades) I ran such simulations because I was new to options and wanted to see in print the untold riches that awaited me. LOL, that's what a noob's dreams are made of. One thing is clear, buying the nearest expiration after the price move provides the most bang for the buck because your cost is the lowest and you achieve more leverage.

As a generalization, for nearer term expiries, the most bang for the buck tends to be somewhere around the midpoint of the up move. The further out in time you go, the more expensive the options and the more leverage you lose. That in turn means that higher delta options perform the best, often ITM if you're really far out in time.