Why Do People Buy In-the-Money Call Options?
Investors often seek out in-the-money (ITM) call options for a variety of reasons. From enhancing portfolio performance with leverage, to hedging against potential losses, ITM call options offer a strategic route for traders and investors alike. Here, we explore the key reasons and benefits behind the popularity of ITM call options.
Intrinsic Value and Profitability
In-the-money call options boast intrinsic value due to their strike price being below the current market price of the underlying asset. This makes them profitable right from the start, providing a safer investment option compared to out-of-the-money (OTM) call options. For example, if you own a call option with a strike price of $400 and the underlying asset (such as a stock) trades at $450, your option is in-the-money, and you already have a portion of the value that can be realized.
Leverage and Cost Efficiency
One of the key attractions of ITM call options is the leverage they offer. Traders can control a significant number of shares with a relatively small investment compared to buying the underlying stock outright. This can lead to substantial profits if the stock price continues to rise. For instance, if you control 100 shares worth $50,000 with a $5,000 investment in an ITM call option, you can see the benefits of magnified gains in a favorable market.
Higher Delta and Price Sensitivity
In-the-money options typically have a higher delta, which is a measure of the option's sensitivity to changes in the price of the underlying asset. A higher delta means that the option price will move closer to the price of the underlying asset. This is a significant advantage because it increases the option's potential for profit if the stock price moves in your favor. For example, a call option with a delta of 0.90 will move 90% as much as the underlying stock, amplifying your gains.
Reduced Time Decay Impact
Another advantage of ITM options is their lower time decay. Time decay is the gradual reduction in the value of an option as the expiration date approaches. In-the-money options are closer to expiration and have more intrinsic value, making them less sensitive to the erosion of time value. This can be particularly advantageous in expiration periods.
Hedging and Speculation
Investors may also use ITM call options as a hedging tool. This is especially useful for investors holding short positions or other investments that could be negatively impacted by a market downturn. By buying ITM call options, investors can effectively reduce the risk associated with potential losses.
Enhanced Equity Strategy
Investors can adopt a more strategic approach to using ITM call options through a method known as "Enhanced Equity." For instance, take the example of NVIDIA (NVDA) trading at $497. If an investor is bullish on NVDA for the next three months, they could either:
Buy 100 shares of NVDA, which would cost $49,700 and yield a one-for-one return on the stock's movement (delta of 1). Buy an ITM call option with a strike price of $435 expiring in March 2024, which has a delta of 0.80 and a price of $78.25. This would cost only $7,825 and would provide an 80% return on the stock's movement (delta of 0.80).If the trade starts working out immediately and the call option continues to deepen in the money, the delta will continue to rise, making the option behave more like the underlying stock.
Cost Reduction with "Poor Man's Covered Call"
For even more cost efficiency, a trader can use the "Poor Man's Covered Call" strategy. This involves buying ITM long-term options (variously referred to as LEAPS) and then offsetting part of the cost by selling shorter-term, out-of-the-money (OTM) call options against it. For example, a LEAP call with a strike price of $385 expiring in June 2025 at a price of $172 can be purchased for a relatively low cost. By selling short-term OTM calls, such as the $515 January 2024 call trading at $6.75, a trader can generate additional income, effectively reducing the net cost of the LEAP.
In conclusion, in-the-money call options are a valuable tool in a trader's or investor's arsenal, offering a combination of leverage, hedging, and cost efficiency. Whether it's for daily trading or longer-term strategies, ITM call options provide a flexible and powerful way to gain exposure to the market while managing risk.