3 ms·
as the distance from the current market price increases, the rule of thumb is that it becomes cheaper because the probability of hitting that strike is a lot lo
by f430 6y ago
as the distance from the current market price increases, the rule of thumb is that it becomes cheaper because the probability of hitting that strike is a lot lower supposedly.
I've read money managers use far OTM options to hedge against a potential shock (high confidence in bad earnings) but you also stand to lose your premium.
Nassim Taleb, Black Swan author, runs a fund that consistently buys far OTM options. They lose money most of the time until that one time where they strike it big. As he describes in "Random Walk in Wallstreet", he cleaned up his desk on the trading floor on Black Monday when his far OTM puts he bought for pennies on the dollar turned into double digit million figure. This is how he made his FU money and has been the subject of emulation by amateurs and professionals alike.
But then you look at people like Jim Chanos who shorted Enron successfully but have not been able to crush Tesla. Had he used options, he would've not only saved a lot of capital, he would still have his skin left in the game.
Not sure I undrestand your second question but I assume you mean near strike OTM vs deep OTM. You have to pay a premium for near strike options or if its in the money.
- platz 6y agoSorry that was a typo, I meant OTM vs ITM So basically you're saying that you can "leverage" more with OTM than ITM?
- f430 6y agoyeah so if your options are ITM then your stock doesn't need to move that much to profit but the downside is its very expensive. OTM is cheaper but much more riskier because your stock has to travel further. No you would leverage more with OTM because you can buy a lot more OTM with the money you spend on ITM. This is a gross generalization, when I say "riskier" it is purely from an academic point of view. In reality there are so many other factors at play, fundamentals, theta, delta, vega, etc. I can't really explain it because I don't understand their exact relationships but in general when you have an option position the clock is against you and so many other factors that has to go right. It's like in Casino Royale when that Marilyn Mason look-alike invests African warlords money on an airline company on far OTM near expiry options and then launching an attack in the airport. The SEC has a safeguard against these things. If you have large far OTM options near expiry and the stock dips the next day, expect a visit from the SEC or FBI.