If you are an investor in the stock market, you can buy the stocks of a company when you believe that the stock price will go up in future. You make a dollar-for-dollar profit if the stock goes up. You will incur a dollar-for-dollar loss if the stock goes down. If the stock offers options, you have a choice to buy either the stocks or call options. In the US, every option contract allows a buyer to control 100 shares of the underlying stocks. A call option gives the buyer the right to buy the stocks of the underlying company at a specific price on or before the expiration date.
Here is the question for you if you decide to buy a call option instead of the underlying stocks. Would you buy an out-of-the-money ("OTM") call because the premium is cheap? Would you buy an in-the-money ("ITM") call because you can make more money even though the premium is expensive? I acknowledge that these questions are not easy to answer and you could get different responses from different people.
Here is my experience. I am aware that some investors have been told to focus on buying ITM call options. More specifically, they should choose an ITM call with an 80 or 85 delta because they were told that this would be the "Sweet Spot" that allows them to make the most money. Because of this, these investors have simply followed the guideline given even though they might not have a clue why this is called the "Sweet Spot". Personally, I find this kind of guideline disturbing because it implies that there is a Holy Grail in options trading. As we all know, there is no such thing called the "Holy Grail" in trading.
What do I mean by "delta"? In options trading, there are a few ways to look at the "delta" of an option. It can be defined as the theoretical probability of the option to expire ITM between the current time and the expiration date. For example, an option with an 85-delta suggests that this option has an 85% theoretical probability to expire ITM between the current time and the expiration date, other things being equal. In other words, this option has a 15% theoretical probability to expire OTM between the current time and the expiration date, other things being equal.
Is an 80 or 85-delta call option always the best? Let us consider this question carefully. I guess one reason why these investors have been told to buy a deep ITM call option is that buying such an option is a good substitute of buying the underlying stocks of the company. Suppose an investor has bought an 80-delta call option. If the stock moves up by $1, the call option premium will move up by $0.80, other things being equal. This sounds good. Nevertheless, we should always remember the downside risk as well. If the stock goes down by $1, the call option premium will be reduced by $0.80, other things being equal. Investors should always consider both sides of the coin.
Does the "Sweet Spot" ever exist in options trading at all? If you still believe that 80 or 85 delta is the "Sweet Spot", I respectfully submit that you should think twice because it does not necessarily translate into a higher profit all the time. In fact, in options trading, there are always other factors to consider and we should not focus only on the "delta" of an option.
Suppose I have bought an 85-delta call for $10. I know that the stock has to move approximately $12 before the option premium doubles in value, other things being equal. Now, suppose I have bought a 20-delta call option for $0.50 instead. I just need the stock to move $2.50 for the premium to double in value. Which is easier and has a higher theoretical probability of success? The answer seems obvious.
Based on the above example, would you still insist on buying an 80 or 85-delta option every time, especially if you know you can find another option that can double the value when the stock just needs to move a little? After all, it is my submission that delta is delta and that is it. As my mentor said, in order to trade options successfully, we have to consider other "greeks", i.e. gamma, vega, theta and rho, as well. We cannot just focus on the delta of an option and think that this is the Holy Grail.