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"Isn't ITM Call Options Risky?"

Question By Tony Guzman

"Isn't ITM Call Options Risky?"

when you buy an ITM call expecting a moderately raise don't you run the risk of getting assigned? so wouldn't you be better off buying an ATM or OTM call so you don't run the risk of assignment?

Asked on 26 June 2009

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Answered by Mr. OppiE

Hi Tony,

I will answer your question in two parts. First, I will address why the risk of assignment isn't that much of a risk buying In The Money options and secondly, I will address the reason why In The Money Call Options may be a lot less risky than at the money or out of the money call options.

First of all, assignment for call options or put options usually happen only when those options are in the money on expiration day itself. The law mandates that if you have an option that is in the money, they should be assigned on expiration day. This also means that your worry about the options being assigned anytime before expiration isn't valid as it don't usually happen that way. Early assignments sometimes do take place commonly for dividend paying stocks just before ex-dividend, that is one thing you need to take note of. This is why you do not need margin to buy call options. If the options are in the money when expiration arrives, you could simply roll forward to the next month call options if you think the stock is going to continue going up or if you think you like the stock, you could also exercise the options or wait for assignment to keep the stocks. Otherwise, if you think the profit so far is good, simply sell the in the money call options for the profit. In fact, when you buy an at the money call option or out of the money call option, you do so with the expectation that the stock will rise past those strike prices, right? Which means that those call options can also become in the money anytime before expiration.

You may have overlooked this but buying in the money call options is actually a lot less risky than buying at the money call options or out of the money call options using the same amount of money.

Lets assume you have $1000 to trade with, ABC stock is trading at $10 and its $10 strike price call options are asking for $1.00 (with bid of $0.70) while its $9 call options are asking for $1.30 (with bid of $1.00). With that same $1000, you could buy 10 contracts of its $10 strike price call options or 7 contracts of its $9 strike price call options. Right from the very instant you put on that position, you would have lost $300 from bid ask spread if you have bought the $10 strike price at the money call options while you would have lost only $210 in bid ask spread on the in the money $9 strike price call options! See? You are starting on a lower starting point buying the at the money or out of the money call options than the in the money call options. Now, assuming ABC remained at $10 at expiration. You would have lost the whole $1000 as the $10 at the money call options expire worthless while you would have lost only $210 on the extrinsic value of the $9 strike in the money call options! See?

In conclusion, do not let assignment fool you into thinking that at the money options or out of the money call options are necessarily safer than in the money call options. Options traders rarely hold til expiration as we take profit as soon as profit taking point is hit and would have sold the options on expiration day itself instead of getting into an assignment. In fact, assignment is not a "risk" per se if the stock is a great stock to hold for a longer period of time. On the same amount of money per trade, at the money call options and out of the money call options actually run a higher risk of loss than in the money call options.

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