It was reported recently that Nancy Pelosi, Speaker of the United States House of Representatives bought 25 TSLA calls with a strike price of $500 on 22 Dec 2020 with an expiration date of 18 Mar 2022.
TSLA shares were $648 that day.
So this made me wonder why she bought deep in-the-market (ITM) call options considering that it would be a lot more expensive due to the intrinsic valueof $148 ($648 less $500)?
Before proceeding with the benefits, we need to introduce a new term called Delta.
Simply put, Delta is the change in option price for every dollar change in the underlying share price.
In this case, if the Delta is 0.9, every $1 increase in TSLA share price will result in a $0.9 increase in TSLA calls.
Benefits of deep ITM calls:
Deep ITM calls have a higher delta (usually between 0.7 to 0.9) compared to ATM or OTM calls.
Options with a higher delta move more in line with the stock price. Since the breakeven is close to the stock price, it serves as a stock replacement (“synthetic stock”).
You can take this “synthetic stock” and sell calls against it, effectively a covered call. By buying long-dated deep ITM calls, you can get premiums by selling shorter-dated or OTM calls.
You pay less extrinsic value when buying deep ITM options. This means that your option value won’t lose as much value due to volatility swings or time decay if the stock price stays up.
Disadvantages of deep ITM calls:
The capital outlay is greater, if TSLA stock price moves against Pelosi, there’s more to lose. But the loss is capped at the amount of premiums she paid.
Generally, deep ITM options have less liquidity. Thus, it is more difficult to get a good price or find a trade.
Disclaimer: I have no opinions on TSLA nor am I able to value it. No position whatsoever. Just trying to break down the reasons for Nancy’s deep ITM calls purchase for learning purposes.