Out of the Money Call vs At The Money Call

Is the out of the money call better? Got a question from a member recently:

I have been looking at stocks, and 1 expert says UNP has the highest value in the s&p 500.  It appears to be doing well.
Please look at the calls with me.

The jan 2012 leap, at 60. I believe is selling at 33, which puts it at 93 and is trading at 93.5.   If you expect it to go to 100 by then , the gain should be 6.5 $ for a 33 $ investment or about 19.7%  over 10 months??  Am I seeing this correctly?? and the math right ???  It appears that the in the money option is a better value than the out of the money ??
A 7 % move giving a 20 % gain????????

Looking at the 100 call, jan 12, it sells for about 5.80.  If it closes at slightly over 100, you may get a dollar gain ???????  or actually, break even is at 105.8?????

What is the correct way to compare an itm vs an otm trade?  I guess that is my real question????

So I looked at the stock to answer his question. The numbers had changed a bit.

UNP was at 95.60 when I looked at it. The Jan 2012 60 strike call was trading at $36. That makes the breakeven $96. The delta on the 60 call was .89. That means the option will gain 89cents for every $1 gain in the stock price. So if UNP is at $100 at expiration, the stock will have gained 4.4% while the option will have gained 11.11%. The return will be better if the stock does well.

Buying a call so far in the money is also called “stock replacement”. You are putting up less money to buy the call and get about the same gain/loss in the option that you get in the stock. Using far in the money options is a great idea when doing covered calls. Since the cost of the long call is cheaper than stock, your returns on the covered call are much greater.

For the At the Money 100 Call, it is trading at $7, so the breakeven is $107. But if UNP goes past $107, the gains will be of a greater percentage.

Say UNP is at 110 at expiration. For the In The Money Call we would make $14 or 38%. With the At the Money Call we would make $3 or 42.8% While the stock moved up 15%

Which one should you choose? The In the Money is the most conservative since it is at about breakeven right now and can gain more than the stock if the stock advances. The At the Money Call is fine if you think the stock will move. In our example I only took the stock to $110. It the stock is at $120 at expiration, the At the Money Call % return would have dwarfed the other two options.

That being said, would you want to wait for almost a year to make 20-30% on these calls? If UNP is going to go up, why not sell Puts month after month and make 8-10% a month? That way, even if UNP stays close to $95, or moves up, or even moves down a little, you can still make money. And if UNP moves down a lot, you just look for another stock. You are not tied into the trade long term like with these calls.

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  1. stan stocki on March 4, 2011 at 8:47 am

    Excellent analysis Allen !!
    Thank you much !!

    • WLS on July 19, 2017 at 7:01 pm

      If UNP goes “down a lot”, in your scenario, you might just look for another stock…with other money, but you will be put the stock so in a way you are tied to that stock until you work out of it, as you know. I’m not sure why you didn’t point that out. Good tutorial tho.

      • Savage on November 15, 2020 at 5:26 pm

        I sell puts far enough OTM that if I get moved against in a hard way I can close out before assignment. Plus… unless a company is going bankrupt the drop will only be so large. You can always trade ETF’s to minimize the frequency of assignment from “down a lots”.

  2. kamlesh on May 23, 2012 at 4:25 am

    hi allen,
    if we sell in the money calls, and buy the stock & trend change and the stock price comes closer to our sold call strike rate and still 15 days left to finish the series, what would be the adjustment?thanks.

    • Genius on May 23, 2012 at 10:50 am

      If You sell in the money calls, you wouldnt adjust because you want to be called. Your profit would be the time premium of the option.

      • kamlesh on May 24, 2012 at 1:29 am

        i am selling in the money calls but at the same time buying same quantity of stocks as well on the first day to get theta ,but what will happen if trend change and stock price go below my sold call strike price, what wud be the adjustment?thanks.

  3. Wayne on January 20, 2014 at 7:34 pm

    Allen, When you do these it would be nice for teaching purposes to use options that are a little more current. I did subscribe to you and realize that your pretty good w/ options. You don’t need to to give anything away but to teach you should be closer to the present. Thanks for sharing your knowledge. I have learned alot. Your Good for the industry.

  4. Ronay on January 25, 2016 at 1:35 am

    I can not truly understand how to determine if a call or put is in the money.
    Please explain by an illustration.

    • Ameen Kamadia on January 26, 2016 at 3:11 pm

      If you have a 50 strike put, if the stock is trading below $50, the option is in the money.

      If you have a 50 strike Call, if the stock is trading above $50, the option is in the money

  5. Barry on January 29, 2016 at 3:45 pm

    Selling a cash secured put (CSP) month after month to capture premium ties up a lot of capital. One contract would require about $10,000 for a $100 per share stock. Are you able to bring in roughly the same total yearly premium ($) with your CSP strategy compared to this long call strategy but having more long call contracts? Of course, one would need to use proper position sizing for their portfolio.
    A similar strategy to this long call would be an ITM call debit spread. This strategy could be done on a monthly basis and tie up much less capital. I am wondering which of the three would be the better strategy?

  6. Fred Overkamp on August 5, 2017 at 1:25 am

    Advisers always talk about holding options til experation. I try to buy calls out of the money of widely held companies with an upward trend for $2 to $5. I like the call to be at least 6 months out. Often you can get 20% to 50% in a few days to a week. Ride with it as it moves up. Dump it quick if it drops. In options as well as stocks be ready to sell if you get near a 10% loss. For a few dollars you can always buy it back if things change.

  7. William A Buie on December 24, 2021 at 10:46 am

    When selling a PUT strike in the money and buyin a PUT strike at the same time (spread) even more in the money what is your Percentage below stock price to have a reasonable gain on weekly options?

    • Ameen Kamadia on January 27, 2022 at 2:58 pm

      That is not something I would do because the chances of getting assigned on the Put are high if you are in the money, especially with so little time left to expiration

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