In Thursday's (March 15, 2001) newsletter, you suggest that if SEBL breaks support at 25 you would go for the April 35 puts. Why do you suggest going so deep in the money? Wouldn't the April 30s provide you with more liquidity? Wouldn't the April 25s afford the best leverage and profit potential? (March 17, 2001)
It is true as a general rule that the short term, at the money options are the most volatile. Put options, however, even with the falling market, are showing lower delta's than their call option counterparts. Thus we prefer to go in the money to obtain a better delta. We would prefer to pay a little bit more and get a better delta. Why? Because the underlying stock does not have to move as far for us to make our profit target. Now we pay more than we would for an at the money option, but the underlying stock would have to move further down to make the same dollar amount of profit. That means we may have to stay in the play longer, and if the play moves against us much at all, it is harder for the option to regain the lost premium than it is for an option a bit further in the money. In this market we like to get in, get our profit, and then get out if the play appears to be stalling. Having a higher delta allows us to do that. Now we won't go pay $30 for an option to make $1; that is too risky even with a good delta. We want to balance how much we are paying versus the delta and the profit potential. That is a personal choice related to individual risk tolerances.
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