How to Maximize Profits with OTM vs ITM Calls in Stock Trading

When traders consider whether to buy Out-Of-The-Money (OTM) or In-The-Money (ITM) calls, the decision is influenced by several key factors, including the time-to-expiry, delta value, market direction, and whether they are buying or selling. This article aims to provide a comprehensive guide on when to use which type of call option to maximize profits in the stock market.

Understanding OTM and ITM Calls

OTM (Out-Of-The-Money) calls give the buyer the right, but not the obligation, to purchase the underlying asset at a pre-determined strike price, which is above the current market price. Similarly, ITM (In-The-Money) calls offer a higher premium due to the intrinsic value, as the current market price of the underlying asset is above the strike price.

Buying OTM Calls

Many traders opt for OTM calls when they have a strong belief that the underlying stock will move in their favor and remain above the strike price until expiry. OTM calls are typically used for intraday trading, allowing for quicker returns and an exit within a short period. However, holding these until expiry is not advisable since the probability of a substantial profit diminishes as time passes. For instance, if on a Monday, the Nifty index is trading at 17150 and an OTM call at 17500 is acquired for 20 rs, a good profit can be made if the Nifty reaches 17450 by mid-week. Nevertheless, if the trade is not closed, the chances of profitability significantly decrease by the time of expiration. If the Nifty remains around 17495, the 20 rs premium will be lost as the option is not exercised due to it being OTM.

Selling OTM Calls

Selling OTM calls is primarily done to capture the time premium and benefit from the expiry effect. The delta for OTM calls is lower, which means that small movements in the underlying asset have less impact compared to ATM (At-The-Money) or ITM options. Traders should only sell OTM calls if the underlying asset is expected to remain at the same level or slowly move towards the strike price until expiry. Otherwise, the risk of losing the premium is high. Common strategies include selling short strangles, which involve selling OTM calls with different strike prices.

Buying ITM Calls

ITM calls are usually purchased when traders are extremely bullish, anticipating a quick profit. These calls come with higher premiums and a higher delta, meaning small changes in the underlying asset can lead to significant fluctuations in the option premium. While ITM calls are typically held until expiration, they are also often used as part of option trading strategies. New traders often favor OTM calls because they are cheaper, but the underlying market movement needs to be sharp and quick for OTM calls to make substantial profits. Trading at strategic levels of breakouts can be profitable.

Conclusion and Tips for Trading

Choosing between OTM and ITM calls depends on a variety of factors and traders' risk appetite. OTM calls are more suitable for short-term strategies and are effective when the underlying asset price moves sharply in a short time frame. ITM calls, on the other hand, offer higher premiums and are ideal for those looking for quick gains. It is crucial to consider the market conditions, the time-to-expiry, and the potential for the underlying asset to move in your favor.

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