Buying DITM (Deep-in-the-Money) options takes full advantage of the DELTA of an option, so that swings in the stock are matched dollar for dollar with the changes in the value of the option.
This a great strategy for those who are still a bit scared of buying options (as you should be!), but love the challenge of swing trading stocks (remind yourself about Swing Trading), and want to gain some leverage on a trade as well as reducing overall risk and cost of investment.
Why Trade DITM Options?
- Profit from the FULL movement of the stock price. DITM options exploit the power of DELTA, which is the greek symbol that measures the rate of change of the price of an option. If the Delta of an option is 1.00, that means the price of the option will change by $1 for every $1 change in the price of the underlying stocks. See more on Delta on Options Greeks Section;
- Buy stock for half the price. Trading DITM options is EXACTLY the same as swing trading. Short term, in and out - a trade is seldom carried for more than 10 days. Doing it this way means you get the same profit for half the investment; or, in other words, you DOUBLE your ROI.
How does it Work?
Options that are ATM (At-the-Money), or trading very close to the price of the stock, usually have a Delta of between 30 and 70, and for most stocks, hover around 50. This means that when a stock moves, only 50% of that move is captured by the change in the price of the option. So, if the stock price increases by $1, an option with a delta of 50 will change in price by 50 cents. ATM options (or near-the-money options) are cheap, but their price movement is much smaller than that of the underlying stock.
Your choice of DITM options is based on the fact that you will find options (calls or puts) that have a delta of 100, or as close to 100 as you can find. This means that every dollar that the stock increases or decreases in price will be matched by the option.
VERY OFTEN these DITM options cost about half the price of the underlying stock price, or less. This means that you can buy either:
100 shares of XYZ at $25 = $2,500
1 DITM Option Call for XYZ at $12 = $1,200.
In other words, you have effectively bought the stock for half price. You miss out on dividends, but that is your only downside. In any case, if you use swing trading as the basis for your trade, you are not going to hold the stock long enough to benefit from dividends.
Now, if your DELTA is 100, or close to 100, you will get the full benefit of the swing. Percentage wise, it is even better! For example, if you are aiming for a 7% profit swing in your stock, the effect will be a 14% swing in your option price. Much better odds!
So, how do you buy DITM calls and puts?
Go to the page entitled "How to Trade DITM Options" for a detailed step by step method. For a real trade example, and a way to use this strategy on ETFs like QQQQ, SPY, IWM and DIA, go to this page.
Advantages of Trading DITM Calls and Puts:
- You invest less money to capture the movement of a stock;
- You have less downside risk (about half of that needed to buy the stock);
- You gain about 100% of the price movement;
- You get a higher return on investment (ROI) i.e. you have higher leverage.
Base your trade on a movement in the STOCK that you anticipate because of your skill in Swing Trading. Do not buy options that have too much time incorporated - DITM options are also affected by Time Decay!
Where to from here?
Return from DITM Options to the Home Page
Or: Review how options are valued, and refresh your memory on the use of DELTA