Advantages and disadvantages of at-the-money option, in-the-money option and out-of-the-money option

Advantages and disadvantages of at-the-money option, in-the-money option and out-of-the-money option
An at-the-money option has both advantages and
disadvantages over stock and in-the-money options. First,
the at-the-money option will be cheaper then both the stock
and the in-the-money option. So there is less capital
requirement and less total risk.

Remember, when buying an option, you can only lose what you
spend. The problem is the amount of extrinsic in the
at-the-money option.

In order for you to profit from buying an at-the-money
option, you need the stock to make a move very quickly.
Because you have so much extrinsic value, you will be
battling against the option's daily rate of decay.

So, the movement of the stock must happen quickly enough
and large enough to offset the amount of money you will be
losing daily as expiration draws near.

With this said, the best chance you have to make money when
buying a naked at-the-money option is to use it as a short
term trade. The longer you hold onto this option, the
harder it is for you to be profitable due to the options
decaying extrinsic value.

At The Money Call vs. In The Money Call

An out-of-the-money option presents many of the same
advantage & disadvantage parameters to the investor. The
out-of-the-money option is even cheaper then the
at-the-money option which means more leverage and less risk.

However, with a smaller delta, the stock must move much
more than either the in or at-the-money options in order
for the options to become profitable. Again, we need the
option's delta to outpace the option's rate of decay.

Now, with the out-of-the-money option, there is less
extrinsic value than the at-the-money option so the amount
of total possible decay (cost of the option) and the rate
of this decay is less than the at-the-money option.

By being further out-of-the-money, this option needs more
movement from the stock. As a naked option, this
out-or-the-money example is extremely speculative and
should only be used naked when the investor feels there is
a very good chance of a stock having a large percentage
move.

An investor must understand that the odds of them profiting
from the purchase of a naked out-of-the-money option is
very slim. When purchasing a naked out-of-the-money option,
be prepared to lose your entire investment.

Out of The Money Call vs. At The Money Call

Although options can be traded by themselves for
directional plays, and can perform well under the right
conditions, they are much better used in coordination with
stock or other options in formatted strategies which will
be discussed in the next section.

While buying naked calls and puts can provide some of the
biggest leverage and highest returns, they can also involve
the most risk. This strategy should only be used by
experienced options traders or traders using risk capital.

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Brett Fogle is the founder of Options University, a
training resource partner for traders. For a
comprehensive, free report on the 7 deadliest sins made
when options trading, visit
http://www.OptionsUniversity.com .