As out of the money options go «into the money,» it could force traders to rebalance their hedges, which in turns further aggravates the move to the downside.
This is a judgement supported by the gyrations in markets induced by relatively small fluctuations in the perceived chance of Brexit and by the very high prices commanded
by out of the money options.
Assuming the Reddit investment club wants to sell at - the - money or
slightly out of the money options, the way to maximize time premium capture with this portfolio is to sell the following June call options (note we aren't covering ORAN or TLK because the June options don't pay enough to make it worthwhile; one could make the same argument for MCD but we decided to leave it in since it's 3.5 % out of the money):
The only thing that gives me a bit of pause there is that PIMCO is a quantitative bond management shop that has historically derived most of its excess returns from quantitative strategies that rely on the equivalent of selling
deep out of the money options against their positions, and mean - reversion, and variety of other things.
For out - of - the - money (OTM) call options (where the call's strike is above the stock's current price), time premium is equal to the option's price (since intrinsic value = 0
for out of the money options).
Investors who have core holdings of non-volatile stocks will often do this —
write out of the money options that have 3 - 6 months of time to expiration.
While at the money options may provide less downside protection than
out of the money options, downside protection is usually a much smaller consideration in a bullish market.
OTM —
An out of the money option is one whose underlying stock value is below the strike price.
Combine this with a 3 % dividend and you're looking at an asset that can generate 9 % to 13 % per year (and because they are
out of the money options you still have some upside potential on the underlying stocks).
Well, as expiration approaches,
out of the money options are approaching 0 Delta and in the money options are approaching 100 Delta, so their Delta will not move as much as the Delta of an at the money option.
You may decide to sell
an out of the money option, collecting less cash, but giving yourself the chance for an upside profit.
I have
some out of the money options with pretty far off expiry dates (Jan 2013, for example).
Note:
These out of the money options are presented with «if flat» returns.
If the strike or target price of the contract that you are buying is above the current price, then you are buying what is called
an out of the money option.
An out of the money option has no intrinsic value, but only possesses extrinsic or time value.
Out of the money options are significantly cheaper than in the money or at the money options, and offer the biggest leverage or bang for the buck if the option trader's view proves to be correct.
This works best as
an out of the money options strategy.
Out of the money options, which require a price movement to become valuable, cost much less.