There are so many nuances to options investing that many advisors and investors basically shy away because it’s easy to quickly get overwhelmed and out of your depth. Derivatives are worth considering, however, because they open up all new avenues to express opinions and provide a kind of insurance about the future performance of stocks, what the market may or may not do, and even the underlying asset.
If a stock is the lever that investors want to pull, options are like dials and switches, fine-tuning how much to pull the lever, when to pull it, and even protecting it from being pulled too far. If they want, they Someone else can be given the right to pull the leverage — at a cost, of course — in the form of a covered call, or a stop-loss level to prevent the leverage from being pulled too far. protective case.
I wrote an article in May that breaks down guaranteed calls and protective puts in more detail, and why advisors might want to use them, which you can find here. Today’s topic is all about monetaryity, whether the contract is in-the-money, in-the-money or out-of-the-money, and what that means for puts and calls.
Monetary is not far from Nessie’s relationship, although sometimes trying to understand it is like probing the depths of Nessie: Monetary is the relationship between the strike price of an option and the price of the underlying asset. It’s an easy way to talk about whether you’ll make money if you exercise the option right away. Putting options and breaking even is considered to be in money; everything beyond that is either in money or out of money, depending on which option and strategy it is.
in call and put options
Options currently “in the money” mean they can be exercised for profit and are therefore generally more expensive than their “out of the money” counterparts. That doesn’t mean they’re better options than no-money options; which one is more applicable depends entirely on the strategy employed.
A call option grants the contract holder the right to buy stock at an agreed strike price within the contract window, while a put option grants the holder the right to sell stock at a predetermined strike price within the contract window. A call option means the strike price is lower than the current price of the stock, while a put option means the strike price is higher than the current price.
Math has a lot more to do with intrinsic value, time value, and extrinsic value, but that’s a deep dive for another day.
call and put options
As you might guess, out-of-the-money means that the option is in the opposite position to the ITM, meaning it is not currently in a profitable position if the option is exercised immediately, but that doesn’t mean investors are just bullish by investing in the OTM Options or puts to waste money.
Examples of ITM and OTM:
- Buy a call option with a strike price of $105. It is an ITM if the price of the underlying asset is above $105, and an OTM if the current price is below $105.
- Buy a put option with a strike price of $100. It is an ITM if the underlying asset is below $100, and an OTM if the current underlying price is above $100.
Currency traders use options for a number of reasons and strategies: Part of their appeal may be that they are cheaper, which also means more volatility than their ITM counterparts, as small price movements can have a bigger impact on returns. They can also be a form of hedging or provide a form of investment insurance. Buying OTM protective puts as a form of insurance for owning the underlying asset during market volatility can protect against large losses at a low cost.
OTM in action
Garrett Paelolla, Managing Director and Portfolio Manager at Harvest Volatility Management, recently discussed the use of OTM puts in risk management scenarios through a collar strategy. The Collar strategy entails taking a stake in the underlying security while buying a protective put option and writing a covered call option on the same security.
For nearly a decade, HVM has been honing how they can use the collar strategy, which generates income and reduces volatility through covered calls, while providing some level of downside protection through protective puts. HVM currently provides portfolio management for Nationwide’s ETF product line.
“Both short calls and puts are executed at the same time every month. We sell calls to fund the purchase of puts,” Paelolla explained. “These put options are roughly 5-10% deducted from funds when they are initially sold.”
The options used are all 30-day maturities and then reset, and as the active manager, HVM can close the call options so that more of the underlying asset can participate in the market rally, or if most of the premium occurs has been captured and the rules have been triggered. The OTM put option remains unchanged for the month, then exercised and reset the following month when its conditions are met.
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The views and opinions expressed in this article are those of the author and do not necessarily reflect the views and opinions of Nasdaq Corporation.