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Chapter 6. Eight winning option trading ... > Stay away from deep out-of-the-money...

2. Stay away from deep out-of-the-money options

The illusion is that deep out-of-the-money purchases give you a lot of leverage. In reality, they give you a lot of hope, encourage over-commitments, and generally offer little profit opportunity. Yes, they hit at times, but this is a game of probabilities, and the odds are certainly against you when buying deep out of the moneys. You have to be realistic. If the premium appears cheap, there's usually a reason. Of course, you could buy an August 900 soybean call in July when the beans are at 600 and hope for a crop failure. You could probably buy a lot of them because they'd be cheap, maybe just a few pennies or $100 each. Yet, it would be unlikely for beans to rise $3.00 per bushel in just three weeks. It may make more sense to purchase a deep out-of-the-money option if you have sufficient time, but then again you lose some leverage because you are paying for time. The odds are greatly in your favor when you sell deep out-of-the-money options, but the expected reward is minuscule in relation to the risk. You could be profitable 99 out of 100 times when selling deep out-of-the-money put options on the stock market, but that crash will inevitably come on some unexpected event when you least expect it. Unless you wish to be “the house,” the one who is capitalized enough to cover its lottery or slot machine jackpot, stay away from deep out of the moneys.


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