Going Deep

Since I "occasionally" make fun of the Deep Call strategy, I just figured why not clarify my thoughts on them?

I don't think it is a *bad* strategy per se, just misleading in the risk/reward picture.

The virtue is supposed to be that you can only lost the "x" dollars you invest in that particular call. But if you lose it, that's 100% of the investment. And you can lose that 100% in a relatively small percentage move in the stock. It all depends on the specifics, but it could mean something like a 10-15% move.

It is also important to allocate the resources properly. A $10 in AAPL is not the same thing as a $10 call in CSCO just because the dollar outlay is the same. It may represent an investment 3 times the size.

Let's say you have $100,000 to invest, and you can buy $50,000 worth of XYZ for *only* $10,000 by using some deep call. There are two extreme ways to look at it. 1) You are only investing $10,000, so you can do 9 more plays like this or 2) You are buying $50,000 of XYZ with an embedded put that limits your loss to $10,000, thus you can only put on one more position like this.

I would lean way more towards the latter approach.

Bottom line is a Deep Call has two advantages as an alternative to stock; the leverage and the embedded put. If the attraction is the former, you are playing with fire.