options: in or out of the money?

Question

a question for any options-knowledgeable people out there...

let's say i'm convinced a stock is going down, and i want to use this to my advantage. however:
- i cannot short the stock
- i am NOT concerned about leveraging my investment (i.e. i can easily afford 1/3 to 1/2 the stock price)

is the best strategy to pick put options that are far in-the-money ( which have deltas close to 1 ) to just follow the stock down?

are there other repercussions of picking these more expensive options, like tax conserations?

Answer 1

You cannot say one choice is better and one choice is worse in all circumstances.

A deep-in-the-money (DITM) put, with a delta near -1, will have a risk profile much more similar to a short stock position than an out-of-the-money (OTM) put.

A DITM put risks more dollars per contract if the stock goes up, but an OTM put can lose a larger percentage more quickly if the stock fails to go down.

A DITM put will make more dollars per contract if the stock goes down, but if the stock drops severely enough an OTM put will earn a much larger percentage.

A far-out-of-the-money (FOTM) put will be very inexpensive, but will usually result in a loss of 100% of your investment. However, the return can be huge if the stock drops below the strike price. FOTM options are often compared to lottery tickets.

There are no tax considerations that I can think of. One other consideration is that sometimes the spread between the bid and ask prices are larger the further the stock price is from the strke price.