Debit/Credit spreads and ditm calls

[damnu812 0]

JUst curious, does anyone have any experience with debit/credit spreads or deep in the money calls instead of buying stock? Want opinions and views on these type of strategies. I know these spreads and the ditm calls are a directional play but is it a low or high probability trade? Ive heard about buying ditm calls instead of stock was less risky than buying stock, but with stock you dont have to fight time decay....your opinions and experience with these types of trades would be appreciated.

[trhanson 49]

I'll try to post some good answers here, but take everything I say with a grain of salt :-)

-is it a low or high probability trade?

DITM calls and spreads are not generaly either way. You can make a good spread, and a good ditm call, and a bad one. It really depends on where the stock is and what the technicals are. When I trade directional strats, I typically like to find a quality company that is in an uptrend and is at a technical bottom (CF was recently there at the end of the month, it hit the bottom of the channel and stalled out for a few days before having a bullish engulfing right at the support). I got in the NOV 205 call for 13.45. If I were to have played a spread there, I probably would have played the 205/215 Bull call spread, but I didn't. A handful of days later, there was a bearish engulfing patter on sep 10 so I dumped it for a 22.12% profit.

That was an example of a good one, but I recently had a bad play with GLW playing the down slope similar where I lost 7.8%.

So they can come in both ways, it depends on your strategy. I've been right on the trades I've actually made more times than I've been wrong, but I also don't make may of these trades becasue I have some strict rules about them.

-Ive heard about buying ditm calls instead of stock was less risky than buying stock, but with stock you dont have to fight time decay

deep in the money calls are used as a proxy to stock that is "expensive" stocks. By expensive I mean the cost per share is high, not that it is fundamentally expensive. Let's suppose you were willing to take the risk on 100 shares of APPL. You would need near $70k to buy it. OR you could buy a JAN 2014 450 call for about $25k. Very little time premium on it that deep in the money. It should have a delta very close to 1. So as long as the call stays deep in the money, you basically have a proxy to the stock at a lower price. Now lets assume that APPL drops $100 in a very short time. Now that option is worth around $17k. The person who had the stock lost 10k, you only lost $8k (because it gained time premium since we are talking about a LEAP). That is why some people think it is "safer".

[Kelly Park 10]

I commonly buy DITM, long dated calls on stocks that I think will be rising for some reason. I don't think they are less risky at all, since (as you say) you have theta to contend with, they are time limited (so you have to be right, at the right time), and their are affectively leveraged (their % gain or loss is greater than the underlying). I guess the reason some think they are less risky is that they are cheaper than buying the stock, but I think that is a dangerous misunderstanding of options. But if you address the risk by using appropriately smaller position sizes, then buying DITM calls allows you to diversify more by having positions in more stocks. And you can still sell covered calls against them, as I typicaly do. BTW, my typical DITM call is 6-12 months out, with a delta of about .90 and I plan to sell them with at least 2 months until expiration.

[damnu812 0]

Thanks Kelly and Hanson. So that is common to go 6-12 months out on ditm calls? How do you determine how deep to go on the strike price for the ditm calls?

[Kelly Park 10]

Just for me, the duration depends on my thesis of overall market conditions and for that stock. I just want to have some fairly low Theta time for my thesis to be correct.

Like Hnason said, you want to be close to 1.00 delta, to capture as much stock mvement as possible, and have as little time value as possible. To get close to that, but not pay too much, I look for about .90 delta.

[ammarmalhas 5]

Guys,

Reading along your comments i thought of selling 1/2 the shares I own in GE and buying an equal number of contracts (shares/100) of calls DIM and with delta close >0.9 with ample time.

I am considering 2014 Call LEAPS strike $15. This will give me about $15 per share in cash which I would like to "park" for a while and wait a drop in the market to reinvest it, in GE.

This strategy will allow me to benefit from price hikes, and suffer the same from price drops. As long as GE does not fall seriously close to $15 and we are not any time near Jan 2014, I think it a good play to carry out in preps for market drop, if it happens soon.

Am I correct here or am I confused and missing something?