Recently, (October and November 03), the giant biotech Amgen
(AMGN) came under some intense pressure, trading down about
$12.00 before it found what appeared to be a decent level of
support, and began to consolidate. At this level, anyone interested
in going long Amgen at a discounted price would be advised to
do so. Implied volatility was high coming off this precipitous
drop, which caused premiums in the options to increase considerably.
This scenario can be a very attractive for trading stock options
or buy-writers. On Tuesday, December 2, 2003, Amgen was trading
at $58.90, the December 60 call was trading at $1.30, and there
were only two weeks left until expiration.
Lets assume that you wanted to start trading stock options
due to this great opportunity but you would be unable to participate
in it due to capital requirements. They started trading stock
options at $58.90 and you did not have sufficient funds to support
trading stock options at that price. After all, the purchase
of just 1000 shares would cost $58,900.00.
This is the time to consider using a trading stock options strategy
called stock replacement. In many instances, an insufficient
amount of funds in the investors account can mean the loss of
a golden trading stock options opportunity when dealing with
high dollar priced stocks.
So, an alternative to purchasing the trading stock options outright
is to find a way to replace the actual trading stock options
with something else which is not as expensive. In this case,
a deep in-the-money call would do just that.
When a call is deep in-the-money, meaning that the strike price
of the call is much lower than the trading stock options price,
the delta of the call approaches 100. This means that there
is close to a 100% chance that these trading stock options will
Because of this, the trading stock options will trade just like
the stock; penny for penny, dollar for dollar (in a theoretical
100 delta scenario.) If you recall, the term delta was mentioned
when describing the option in question. Delta is the first derivative
of the stock and it has a three pronged definition. The first
is percentage change.
The delta is given as a percentage change, meaning how much
in percentage terms the trading stock options price will change
with a movement in the stock. A 50 delta option will move 50%
the amount the stock does. If the stock moves $1.00, than the
trading stock options move $.50. A 30 delta option moves $.30
on a $1.00 movement in the trading stock options, and so on.
Delta can also be defined as percent chance. This is used to
describe the percentage chance that the trading stock options
will end up in-the-money. A 90 delta option has a 90% chance
of finishing in-the-money.
Finally, delta can also be defined as hedge ratio which is the
amount of deltas needed to properly hedge a position.
It was important to explain the meaning of delta to understand
that the deep in-the-money call would perform and act just like
trading stock options. One way to determine if the call you
will select is in-the-money enough for your purpose is the delta.
A delta in the mid or high 90s is an ideal candidate.