Deep-In-The-Money

If you are bullish long-term bullish on a stock yet cannot afford to own a 100 shares of stock, you can consider DITM call option in long theta (at least a year) to enjoy slow decaying. There are many benefits for doing this like improving your investment cashflow, enjoy ROI and reducing capital risk.

How option price derived:

  •         An option’s price (premium)= Intrinsic value + Time value (Extrinsic Value)

Most of the option’s value comes from intrinsic value not time value. A stock price at $200, a DITM call option at $150 means intrinsic value is $50. Typically from 80- 90 delta for options moves 1:1 with stock movement.

DITM have minimal time value because their outcome is almost certain. The time value shrinks to $0 because market speculation decreases as expiration approaches. Long theta means lose less value per day, barely time premium to erode. Long theta is your friend!

 

Pick a long theta and choose right delta:

  •     Choose a leaps call more than a year because time decay faster in the short term may affect time value.
  •       Choose 90 Delta Deep-in-the-money because there’s huge value in this contract for margin of safety, as the time value decay slowly.
  •        Buy when IV is low to capture a better upside.
  •    Options have widen spreads, impacting exit cost.

Calculate the breakeven:

  • Breakeven= Strike Price + Option Cost

Since most of the premium is intrinsic value, strike + premium is your breakeven

Relationship between IV Crush and DITM?

When that happened, there’s less volatility premium to lose because DITM derive most of their value from intrinsic value not extrinsic value (time value + volatility premium).

When to exit:

  • The stock price near your target price.
  • Market volatility jumps will resulting option value goes up.
  • Time value is slipping away, It’s better to exit before 6 months.

Risk Management

If the stock price drop, the call option also lose value. To minimise the risk of time, choose a long theta(> 1 year) because time value less volatility just remember time decay fastest in the last 6 months. Selling the position if fundamental not align to your research and you still collect cash. 

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