Subscribers often ask "once you decide to purchase an option how do you select a strike price?” For most actively traded stocks there are dozens of option strike prices to choose from. At option expiration an option loses all time value and is comprised of only intrinsic value. An ‘in-the-money’ call option is comprised of both time value and intrinsic value. The deeper an option is ‘in-the-money’ the more intrinsic value it will have. An ‘in-the-money’ call option does not require a large upward price move in the underlying stock to break even or to produce a profit. An ‘out-of-the-money’ does require a large upward price move in the underlying stock to break even or to produce a profit.

Of course, ‘out-of-the-money’ options will produce a higher percentage return than ‘in-the-money’ options if there is a substantial price increase in the underlying stock. But remember that when you invest in options you must be correct not only about the future price movement of the underlying stock but you must also be correct about the time frame during which this movement must occur (before option expiration). You must plan on the possibility that you are not correct about the price movement and/or time frame. If you are wrong about the price direction or time frame you could lose your whole investment with an ‘out-of-the-money’ option. This is not an acceptable risk if you want to ‘stay in the game’ after unanticipated market corrections or price declines.

After many years of trying to ‘Hit a Home Run’ by investing in ‘out-of-the-money’ options I realized that this type of strategy was too risky as I had too many ‘out-of-the-money’ options expire worthless. No matter how good your stock selection is, there will be periods when you are wrong and cannot afford to risk your options expiring worthless.         

Every trader has a different risk tolerance and must decide if they want to trade ‘in-the-money’ call options with lower risk and a smaller profit potential or ‘out-of-the-money’ calls with higher risk but also with greater profit potential. Purchasing an ‘out-of-the-money’ call option requires a substantial price increase in the underlying stock price in order to be profitable and incurs considerably more risk than an ‘in-the-money’ option. A flat or slightly down price movement in the underlying stock at option expiration can result in a total loss of your investment for an ‘out-of-the-money’ option.  

I subscribe to several option advisory services as I am always learning new ways to profit from options. The tables below list the recent open and closed trade record for a popular option service that I subscribe to as of September 25^th. This service only makes recommendations to purchase ‘out-of-the-money’ options hoping to make huge profits on lower cost options. But you can see from the track record below that the last 12 recommendations are all losers with an average loss of 68.1% demonstrating how difficult it is to make money with ‘out-of-the-money’ options. All out ‘out-of-the-money’ options expire worthless at option expiration and you can see from the 'Closed Trade Record' table below that all of the closed trades expired worthless or close to worthless.

 All Out-of-the-Money Options Expire Worthless at Option Expiration

Open Trade Record               

Closed Trade Record

When I purchase a call option or recommend a call option purchase to my subscribers I normally invest in ‘in-the-money’ options which incur less risk than ‘out-of-the-money’ options. The copy of my brokerage account Profit/Loss Report below shows $254,006.83 in open trade profits generated from purchasing ‘in-the-money’ options. All trades are profitable with an average return of 114.9%. In this example investing in ‘in-the-money’ call options helped contribute to a high percentage of winning trades.

Advantages of ‘In-the-Money’ Call Purchases versus ‘Out-of-the-Money’

 ■ ‘In-the-Money’ calls contain less time value and more intrinsic value

 ■  Does not require large stock price increase to breakeven or profit

 ■  Fewer ‘total losses’ of investment

 ■  Less overall risk

 ■  Higher percentage of winning trades