Out of the Money Stock Options Vs In the Money Stock Options

Option trading is a great way to increase your potential returns in the stock market. But even with options there is room for risky traders and less risky traders.

If you want to be a more conservative option buyer you can always buy in the money stock options. If you feel like taking on a little more risk with a little higher possible reward out of the money options can be a good alternative.

So let's look at each of them separately. An in the money stock option is an option that already has some intrinsic value in it. For example, we find a stock trading at $42 and are expecting it to go up to $50.

The $35 call would give us the right to buy the stock at $35 on or before a given date. If we were to buy the $35 call it would be considered an in the money option because it already has $7 of intrinsic value. Unless this stock drops very far in the near future for it to be below our strike price of $35 we would not lose our entire investment.

Also if the stock goes up at all the option will be profitable, as long as things like time value and volatility do not work against you. And if it goes up far enough the option will be profitable regardless of those other factors.

Out of the money options are a little different. They have a little higher risk, but also give you a higher possible reward. Let's take the same stock trading at $42; we still are expecting it to come up to around the $50 level.

This time we buy the $45 call on it. Because our call has a strike price above the price of the stock it has no intrinsic value. Instead the stock needs to come up for us to make any profit.

If the stock closes below $45 by expiration we would most likely lose 100% of our investment, making it very risky. However if the stock does what we are expecting it to do the position would be much more profitable than either buying the stock, or buying an in the money option.

So which strategy is for you? It depends how risky you want to be, or even if you want to get into option trading. Options can be very profitable, but you need to consider all factors before jumping in.

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