Buying deep out-of-the-money options seems like a great idea to some. Beginners are often attracted to this strategy because the options cost so little and can offer a huge reward. Unfortunately, while these options might be “cheap” they are rarely a bargain.
Traders need the stock to have a massive move in a short space of time for these options to become profitable. Certainly, it can happen, but the majority of the time these options expire worthless.
CONS OF OUT-OF-THE-MONEY OPTIONS
As with all long options, time is not on your side, and these options will be decaying every day. Also, the option’s delta will be so small that even if the stock does make a big move, it is unlikely that the option will change much in price.
Additionally, the cost of getting in and out of the trade can be large, especially when taken in percentage terms. Let’s say you buy a call option and the spread is $0.20 to $0.60. It’s unlikely you’ll be filled at $0.40 so you will likely need to buy the option for $0.45 of $0.50. Even at the initiation of the trade, you are down potentially 25%.
Out-of-the-money puts can potentially have some value in a portfolio from a hedging / insurance perspective, but even then the cost of the insurance likely outweighs the potential gain over the long term.
SUMMARY
There are many factors in play with options pricing and buying deep out-of-the-money options has a very low success rate. Traders need to the stock to make a big move and to make it very soon after entering the trade. Not only do traders have to be right on the direction, they have to be spot on with their timing as well. That’s very hard to do consistently.
