Deep in the Money: How Options Traders Maximize Returns by Going Deep

You wouldn't believe it, but some of the most successful traders almost never aim for the “safe” options. They’re not playing it safe; they’re diving deep—deep in the money, that is. The phrase itself might sound technical or exclusive to Wall Street jargon, but it carries a simple truth: Deep in the money options offer a unique and highly effective way to maximize profits while minimizing risks. But here’s the catch: it’s not as simple as it sounds.

Imagine you’re holding a lottery ticket, and the odds of winning are higher than most people realize. This is what trading deep in the money options feels like for seasoned traders. While most retail investors stick to buying out-of-the-money options, hoping for a big win on minimal investment, they’re ignoring the more secure and controlled approach of going deep. It’s like having a guaranteed seat at the table, but the table happens to be in a VIP section, where you’re more in control of your destiny.

Now, you might wonder, “Isn't this too safe to yield high returns?” That’s exactly the point. The beauty of deep in the money options is that they allow for significant leverage, while providing more stability compared to other forms of option trading. You don't have to gamble on volatility; you simply need to understand how the game works.

What Exactly Does “Deep in the Money” Mean?

Let's unpack that jargon first. An option is considered “deep in the money” when its strike price is well below (for call options) or well above (for put options) the current market price of the underlying asset. In essence, you’re buying an option that already has intrinsic value, which sets it apart from out-of-the-money options that are more speculative.

For example: if a stock is trading at $100, a call option with a strike price of $80 is considered deep in the money. You’re essentially betting on something that is already happening, which is a major confidence booster for many traders. You’re not hoping for the stock to rise to make a profit; it’s already there. The question then becomes, how far can you ride the wave?

The Leverage Factor

One of the key advantages of trading deep in the money options is leverage. For a fraction of the price of the underlying stock, you can control a much larger position. This means your potential returns can be magnified compared to simply owning the stock outright. And since the option is already deep in the money, the price movements of the underlying stock will have a more direct impact on your option's price. In this way, deep in the money options act almost like synthetic stock ownership, but with the added benefit of lower capital requirements.

For example, if you purchase a deep in the money call option on a stock trading at $100, with a strike price of $80, you only need to pay the premium, say $25, rather than the full $100 per share. If the stock rises to $120, your profit potential is much greater than it would have been if you had simply bought the stock.

Minimizing Risk

Here’s where it gets interesting for those who are risk-averse but still want to take advantage of the options market. Deep in the money options reduce the likelihood of total loss. Unlike out-of-the-money options, which can expire worthless if the underlying stock doesn’t move in the right direction, deep in the money options have intrinsic value, so there’s a built-in buffer against total loss. Even if the stock price doesn’t move much, you won’t lose everything.

Compare this to buying a call option that’s out-of-the-money. You need the stock price to rise dramatically just to break even. With deep in the money options, the stock already has to move in your favor for the option to be deep in the money.

The Role of Volatility

Volatility is the enemy of out-of-the-money options traders but a tool for those trading deep in the money. With deep in the money options, you’re less exposed to the unpredictable nature of volatility. You’ve already captured value, so small movements in the stock won’t drastically affect your position.

On the flip side, volatility can help you when the market moves sharply in your favor. Deep in the money options provide a smoother ride; you benefit from the stock’s natural movement without the stress of hoping for extreme market fluctuations.

Analyzing a Real-World Example

Let’s put this theory into practice with a hypothetical trade. Consider XYZ stock, which is currently trading at $150. You believe the stock will continue to rise steadily due to strong earnings reports and market trends. You could buy a call option with a strike price of $160 for $5, but that’s out-of-the-money, meaning the stock has to increase by at least $10 just for you to break even. Instead, you decide to purchase a deep in the money call option with a strike price of $120 for $35. Here’s why:

• Higher Intrinsic Value: The deep in the money option already has $30 of intrinsic value ($150 market price minus $120 strike price).
• Leverage with Less Risk: You’re paying $35 for control over 100 shares, but $30 of that is already intrinsic value. You only need the stock to rise by a small margin to make a profit.
• More Predictable Returns: Since the option is deep in the money, small movements in the stock price will have a direct impact on the option price.

If the stock rises to $160, the out-of-the-money option might give you a large percentage gain, but only if you’re right about the timing and magnitude of the move. The deep in the money option will also increase in value, and with less uncertainty, because your risk was already minimized.

Why Aren’t More Traders Going Deep?

One reason many traders shy away from deep in the money options is that they can be more expensive upfront. The premium you pay is higher because you’re purchasing an option with intrinsic value. However, for experienced traders, this is a small price to pay for the combination of leverage and security. You’re paying for certainty and, in the long run, that pays off.

Additionally, many retail investors are drawn to out-of-the-money options because of the lottery-ticket appeal—the idea that a small amount of money can yield massive returns. However, seasoned traders know that the market is not about gambling; it's about managing risk and increasing your probability of success.

Conclusion: How to Start Trading Deep in the Money Options

If you’re intrigued by the idea of deep in the money options, the first step is to familiarize yourself with the options chain of your favorite stocks. Look for options that are at least 10% deep in the money, with enough time before expiration to ride any potential price movements. Start small, and as you gain confidence, you can scale your trades.

The key takeaway? Deep in the money options offer a balanced approach to trading that combines leverage with a higher degree of certainty. It’s not about chasing extreme returns with risky bets; it’s about maximizing your potential in a way that’s both strategic and secure.