Ch 6 | How ITM Works

Here is a glossary of key terms and concepts from Chapter 6:

Drawdowns: Drops in your account value caused by market swings. Big drawdowns are dangerous because they require a much higher percentage gain just to get your account back to its starting point.

Expiring Worthless: What happens to an option when the underlying stock fails to reach the strike price before time runs out. Because there is no reason to exercise the option, you lose 100% of the premium you paid.

ITM Exit Signal: A specific indicator used in the strategy to warn that the market is about to dip, telling you to sell your bullish positions and move to the sidelines (or use a bear market strategy) to protect your capital.

ITMS (ITM Small): A variation of the main ITM strategy designed for traders with smaller account balances. It uses the exact same principles but applies them to a lower-priced ETF.

LEAPS: Options that have over a year until their expiry date. The author notes that these are not used in the ITM strategy because you end up overpaying for the time value.

Leverage: The way options can magnify your returns. In the ITM strategy, leverage essentially doubles the market’s return—if the index goes up 10%, your DITM options go up 20%, but it will also double your losses if the market drops.

Liquid Market: A market environment with a massive amount of buying and selling happening every day. High liquidity ensures you will never get stuck with an option position you can’t sell.

Market Makers: Entities that ensure market liquidity by providing a “bid” and an “ask” price for every single option strike.

SPX: The S&P 500 index. It is the benchmark that the strategy aims to mirror and multiply.

SPY: An Exchange-Traded Fund (ETF) that moves in lock-step with the SPX. It is considered the “workhorse” of the strategy because it is the world’s largest ETF, boasts roughly 8 million options traded daily, and provides the highly liquid market needed to trade safely.