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This is a level 2 question.
I see a lot of at-the-money put and call options being traded. For example, a stock is trading at 60 and the options most actively traded are for the June or July 60 strikes. What is the motive for this type of trade and what are the monetary goals a trader is most likely trying to achieve with this motive?
There are a variety of motives that induce a trader to choose an at-the-money option over an in-the-money or out-of-the-money option. It is partly because some option properties reach their peak for at-the-money options. For instance, volatility is most sensitive on at-the-money options. Therefore, if a trader wishes to speculate on the rise or fall of volatility he would probably pick an at-the-money option as his or her first choice.
For traders who are short options and want to reduce their risk, an at-the-money option could be the most logical choice. This is because the gamma (speed of the option) is the fastest when trading at-the-money, whereas in-the-money and out-of-the-money options move slower. Subsequently, if you are speculating on a directional move you could pick an at-the-money option and use the gamma (the option's speedy response) to help your trading and profit potential.
Likewise, time decay (theta) is greatest for an at-the-money option. Sellers like at-the-money options because as at-the-money options approach expiration their time decay (theta) rates start to increase. Thus, traders accumulate profits at a faster rate.
Another concern is liquidity. Liquidity, or the ability to get in or get out of an option position without being subjected to a large price skid, is a prime factor for a lot of traders. Because at-the-money options have the benefits listed above, you'll see greater interest and liquidity for them.
I hope this has helped explain why so many people trade at-the-money options. However, at-the-money options aren't always the best to trade in every situation. Your price outlook and investment horizon should primarily determine the best option to purchase. Thanks for writing and good luck with your trading.
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Question Level Key
Level One--Basic Jargon, Definitions, Basic Mechanics of Trading.
Level Two--Introductory Points, Practical Points and Simple Strategies
Level Three--More Advanced Strategies and Repairs
Level Four--Risk Management, Psychology, and How Best to Evaluate Things.
Level Five--High end questions concerning Portfolio Analysis, Managing a Portfolio
of Options, Option Pricing Models, and Nuances of Trading. Included could be a variety of
other topics.
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