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.

RELATED FAQS
  1. Why should I consider buying an option if it's out-of-the-money?

    Learn when a trader may want to buy out-of-the-money options either for hedging purposes or to profit if the underlying stock ... Read Answer >>
  2. Are there any risks involved in trading put options through a traditional broker?

    Explore put option trading and different put option strategies. Learn the difference between traditional, online and direct ... Read Answer >>
  3. How do traders use out-of-the-money options to hedge?

    Learn a couple of simple option trading strategies that traders can use to hedge an existing market position and protect ... Read Answer >>
  4. Do options make more sense during bull or bear markets?

    Understand how options may be used in both bullish and bearish markets, and learn the basics of options pricing and certain ... Read Answer >>
  5. How can derivatives be used to earn income?

    Learn how option selling strategies can be used to collect premium amounts as income, and understand how selling covered ... Read Answer >>
  6. How do speculators profit from options?

    As a quick summary, options are financial derivatives that give their holders the right to buy or sell a specific asset by ... Read Answer >>
Related Articles
  1. Trading

    The Dangerous Lure Of Cheap Out-Of-The-Money Options

    Betting on an expected move is fine, but one must understand the risks involved in a position - and consider the alternatives.
  2. Trading

    How to Make Money by Trading Index Options

    Index options are less volatile and more liquid than regular options. Understand how to trade index options with this simple introduction.
  3. Trading

    Getting Acquainted With Options Trading

    Learn more about stock options, including some basic terminology and the source of profits.
  4. Trading

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
RELATED TERMS
  1. In The Money

    1. For a call option, when the option's strike price is below ...
  2. At The Money

    A situation where an option's strike price is identical to the ...
  3. Step Premium

    A type of option where the cost of purchasing the option is paid ...
  4. Exotic Option

    An option that differs from common American or European options ...
  5. Far Option

    The option with the longer time to expiration in a calendar option ...
  6. Put Option

    An option contract giving the owner the right, but not the obligation, ...
Hot Definitions
  1. Fixed-Income Security

    An investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. ...
  2. Free Cash Flow - FCF

    A measure of financial performance calculated as operating cash flow minus capital expenditures. Free cash flow (FCF) represents ...
  3. Leverage Ratio

    Any ratio used to calculate the financial leverage of a company to get an idea of the company's methods of financing or to ...
  4. Two And Twenty

    A type of compensation structure that hedge fund managers typically employ in which part of compensation is performance based. ...
  5. Market Capitalization

    The total dollar market value of all of a company's outstanding shares. Market capitalization is calculated by multiplying ...
  6. Expense Ratio

    A measure of what it costs an investment company to operate a mutual fund. An expense ratio is determined through an annual ...
Trading Center