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Deep In The Money Call Options - Better Than Stocks - No Kidding!
Lee Lowell - The Smart Option Seller
Overview
This video explains the advantages of buying deep-in-the-money (ITM) call options as an alternative to purchasing shares of stock. The presenter argues that ITM calls can significantly reduce upfront costs, lower risk, and potentially yield much higher percentage returns compared to owning stock directly. The video details the criteria for selecting ITM calls, including a bullish outlook, sufficient time to expiration, and a high delta (around 0.90), and illustrates these concepts with a real-world example using Cisco stock.
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Chapters
- Buying deep-in-the-money (ITM) call options can save thousands of dollars compared to buying 100 shares of stock.
- This strategy can slash risk by a significant percentage and offer substantially higher potential returns.
- The core idea is to use ITM calls when considering the purchase of at least 100 shares of a stock.
- The video promises a detailed example with real numbers to demonstrate these benefits.
Understanding this alternative investment strategy can help you allocate capital more efficiently and potentially achieve greater profits with reduced upfront risk.
The presenter states that buying deep ITM calls can save thousands of dollars, slash risk by thousands of percent, and offer at least triple the return on investment compared to buying shares.
- Call options are a bullish strategy, requiring an expectation that the stock price will rise.
- Strike prices are categorized as out-of-the-money (above current stock price), at-the-money (closest to current price), or in-the-money (below current price).
- Deep ITM calls have strike prices significantly below the current stock price.
- Key criteria for selecting deep ITM calls include: a bullish outlook, a long expiration date (e.g., nearly a year out), and a high delta (at least 0.90).
- A high delta means the option's price will move closely with the stock's price movements (e.g., a $1 stock move results in a $0.90 option price move).
Knowing the definitions and selection criteria for deep ITM calls allows you to identify suitable opportunities and understand why they behave similarly to stock ownership but with leveraged financial benefits.
If a stock is at $100, calls with strike prices of $90, $80, or $70 are considered in-the-money. A call with a 0.90 delta means its price will move approximately 90% of the stock's price movement.
- The example uses Cisco stock, currently trading around $68.30, with a target of breaking its all-time high from 2000.
- A deep ITM call option is chosen with a $52.50 strike price and an expiration date in June 2026 (250 days out).
- This option has a delta of approximately 0.888 (close to the 0.90 target) and a premium (cost) of $18.30 per share, totaling $1,830 for one contract (100 shares).
- Buying 100 shares of Cisco at $68.30 would cost $6,830, demonstrating an upfront saving of over $5,000 by choosing the call option.
This concrete example quantifies the cost savings and risk reduction achievable with deep ITM calls, making the abstract benefits tangible.
Buying 100 shares of Cisco at $68.30 costs $6,830. Buying a deep ITM call option with a $52.50 strike for $18.30 per share costs $1,830, saving $5,000 upfront.
- Maximum loss on the call option is the premium paid ($1,830), a 100% loss of investment, but $5,000 less than the stock's potential $6,830 loss.
- The stock's break-even price is its purchase price ($68.30).
- The call option's break-even price is the strike price plus the premium ($52.50 + $18.30 = $70.80).
- If Cisco reaches $140 by expiration, the call option yields a profit of $6,920 (378% return), while the stock yields $7,170 (105% return).
- Although the dollar profit is slightly less for the option, the percentage return is nearly four times higher.
This comparison highlights that while both strategies can result in a total loss of investment, the ITM call option offers significantly amplified returns on the upside for a fraction of the initial capital.
At $140 stock price, the call option returns 378% ($6,920 profit on $1,830 investment), whereas the stock returns 105% ($7,170 profit on $6,830 investment).
- The video uses an options calculator (barchart.com) to verify theoretical values and deltas.
- At expiration, you have three main choices: exercise the option (requires paying the remaining balance for the stock), sell the option to take profits, or roll the option to a later expiration date.
- Exercising the option means paying the strike price ($52.50 x 100 = $5,250) in addition to the premium already paid.
- Selling the option allows you to capture profits or cut losses before expiration.
- Rolling involves selling the current option and buying a new one with a later expiration date if you remain bullish.
Knowing your options at expiration is crucial for managing your trade effectively, whether you aim to own the stock, realize gains, or extend your position.
If Cisco reaches $140, the call option is worth $87.50 ($140 - $52.50 strike). After subtracting the $18.30 premium, the net profit is $69.20 per share, or $6,920 per contract.
- Deep ITM calls do not offer dividends or voting rights, unlike owning stock.
- A stop-loss strategy (based on stock price, percentage, or dollar amount) is recommended for managing risk.
- The primary benefits of ITM calls are significant capital savings and amplified percentage returns.
- This strategy is most effective when you have sufficient capital to buy 100 shares but choose the option for leverage and cost efficiency.
- The presenter promotes an ebook on using this strategy by following Warren Buffett's stock picks.
Implementing risk management and understanding the trade-offs (like missing dividends) are essential for successful options trading and long-term investment success.
A stop-loss could be set if the stock price drops by a certain percentage or falls below a key support level, prompting the sale of the option to limit losses.
Key takeaways
- Deep-in-the-money call options can be a powerful tool for investors seeking to leverage their capital and potentially achieve higher returns than traditional stock ownership.
- The primary advantages of deep ITM calls over buying stock include significantly lower upfront costs and reduced capital at risk.
- A high delta (0.90+) is crucial for deep ITM calls, ensuring their price movements closely mirror the underlying stock's price.
- While the maximum percentage loss on an option is 100% of the premium paid, the dollar amount lost can be substantially less than the potential loss from owning stock.
- The break-even point for a call option is its strike price plus the premium paid, requiring the stock to rise further than its purchase price to become profitable.
- At expiration, traders can choose to exercise the option, sell it for profit/loss, or roll it to a later date.
- Deep ITM calls do not provide dividends or voting rights, which are benefits of direct stock ownership.
Key terms
Call OptionDeep-in-the-Money (ITM)Strike PricePremiumDeltaExpiration DateBreak-Even PriceExercise OptionRoll Option
Test your understanding
- What are the main financial advantages of buying deep-in-the-money call options compared to buying 100 shares of stock?
- How does a high delta (e.g., 0.90) in a call option benefit the investor, and why is it important for deep ITM calls?
- What is the calculation for the break-even price of a call option, and how does it differ from the break-even price of owning stock?
- When considering the potential outcomes at expiration, what are the three primary actions an investor can take with a deep ITM call option?
- What are the key differences in benefits (e.g., dividends, voting rights) between owning stock and owning a call option?