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Chapter 6. Eight winning option trading ... > Stay away from deep in-the-money opt...

1. Stay away from deep in-the-money options

The key advantages to buying options are the high leverage and the limited risk. If an option is deep in the money, it cuts down on your leverage and adds to your risk. Even though the risk is still limited, you're paying more and therefore have more to lose. You cut down on your leverage, because you need a bigger move in the underlying asset to generate a significant profit. The whole idea of leverage is to take a small amount of money and have the option to exercise into an asset worth many times as much. When buying deep in-the-money options, you tie up a lot more money that can be used for other opportunities. I don't like selling deep in-the-money options either. You tie up a considerable amount of capital this way (since you need to margin the position). The biggest advantage to the option seller is time decay, and deep in-the-money options have less time value; therefore, you have less to gain the easy way and more risk with the intrinsic value component. Bottom line, I stay away from deep in-the-money options when buying or selling. Of course, when buying options, your objective is to turn an out-of-the-money, at-the-money, or slightly in-the-money option into a deep in-the-money option. Your objective when selling options is to avoid turning your sale into a deep in-the-money. This is an effective way for your wallet to go deep out of money!


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