Should I buy options that are in the money or out of the money?

By Casey Murphy AAA
A:

Choosing which specific option to buy can often be a complicated process, and there are literally hundreds of optionable companies to choose from. The interesting thing about options is that the various strike prices of each series accommodate all types of traders and strategies.

When it comes to buying options that are in the money or out of the money, the choice depends on your outlook for the underlying security and your risk tolerance level. Out-of-the-money options are less expensive than in-the-money options, which in turn makes them more desirable to investors with little capital. However, out-of-the-money options are also regarded as bearing higher risk because there is a greater probability that they will end up being worthless upon expiration. Generally speaking, traders who use out-of-the-money options have a higher expectation of a larger move in the price of the underlying than traders who use in-the-money options.

When it comes to returns, the out-of-the-money options often experience larger percent gains/losses than the in-the-money options, which again is due to the higher amount of risk. Since out-of-the-money options have a lower price, a small change in their price can translate into very large percent returns. For example, it is not uncommon to see the price of an out-of-the-money call option go from $0.10 to $0.15 in one day, which is equivalent to a 50% price increase. These high returns make these options attractive to novice traders, but you should keep in mind that many out-of-the-money options also fall 50% or more in one day.

The options you choose to trade should be determined by your risk tolerance, investment strategy and overall view on the direction of the underlying asset.

For further reading, check out our Options Basics Tutorial.

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