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. What assumptions are made when conducting a t-test?

    The common assumptions made when doing a t-test include those regarding the scale of measurement, random sampling, normality ... Read Full Answer >>
  2. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  3. How are double exponential moving averages applied in technical analysis?

    Double exponential moving averages (DEMAS) are commonly used in technical analysis like any other moving average indicator ... Read Full Answer >>
  4. How do you know where on the oscillator you should make a purchase or sale?

    Common oscillator readings to consider making a buy or sale are below 20 or above 80, respectively. More aggressive investors ... Read Full Answer >>
  5. What are the alert zones in a Fibonacci retracement?

    The most commonly used Fibonacci retracement alert levels are at 38.2% and 61.8%. A 50% retracement level is also commonly ... Read Full Answer >>
  6. How was the Fibonacci retracement developed for use in finance?

    The use of Fibonacci retracements in stock trading was popularized by noted technical analysts W.D. Gann and R.N. Elliott. ... Read Full Answer >>
Related Articles
  1. Charts & Patterns

    Understand How Square Works before the IPO

    Square is reported to have filed for an IPO. For interested investors wondering how the company makes money, Investopedia takes a look at its business.
  2. Trading Strategies

    The Top Spread-Betting Strategies

    What are the most commonly followed spread-betting strategies (in countries where it's legal)?
  3. Home & Auto

    Avoiding the 5 Most Common Rent-to-Own Mistakes

    Pitfalls that a prospective tenant-buyer could encounter on the road to purchase – and how not to stumble into them.
  4. Trading Strategies

    Who Actually Trades or Invests In Penny Stocks?

    Although penny stocks are highly speculative, millions of people trade them daily. Here are 10 different types who do.
  5. Chart Advisor

    4 Stocks Still Flashing Buy Signals

    In the midst of volatility and a big market sell-off last week, these stocks are flashing buy signals.
  6. Home & Auto

    Renting vs. Owning: Which is Better for You?

    Despite the conventional wisdom, renting might make more financial sense than you think.
  7. Technical Indicators

    Understanding Trend Analysis

    Trend analysis is the use of past performance to predict future price movement of a security.
  8. Investing Basics

    Explaining Options Contracts

    Options contracts grant the owner the right to buy or sell shares of a security in the future at a given price.
  9. Home & Auto

    When Are Rent-to-Own Homes a Good Idea?

    Lease now and pay later can work – for a select few.
  10. Trading Strategies

    How To Buy Penny Stocks (While Avoiding Scammers)

    Penny stocks are risky business. If want to trade in them, here's how to preserve your trading capital and even score the occasional winner.
RELATED TERMS
  1. Derivative

    A security with a price that is dependent upon or derived from ...
  2. Security

    A financial instrument that represents an ownership position ...
  3. Series 6

    A securities license entitling the holder to register as a limited ...
  4. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability ...
  5. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...
  6. Strike Width

    The difference between the strike price of an option and the ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!