How do I select a strike price?

When trading options, you have the ability to make trade-offs using both the trade direction (long vs. short) and strike price. As a trader, your decision is to trade-off between 1) the amount you can possibly gain, 2) the cost or max loss of the trade, and 3) the likelihood of trade success.

Long out-of-the-money (OTM) options have a low cost, compared to at-the-money (ATM) or in-the-money (ITM) strikes. If the underlying moves to the point where this strike is now in-the-money, the ROI will be higher than an ATM or ITM contract due to the lower initial cost. However, a trade-off with the low cost and high ROI potential is that the likelihood of trade success is also low. Long OTM will only have extrinsic value so time decay will have a greater proportional impact compared to ATM or ITM contracts.

ITM and ATM options have a higher cost but the likelihood of trade success is also higher. ITM and ATM options have both intrinsic and extrinsic value so the ‘delta’ for these contracts will be higher due to the intrinsic value. Delta is one of the option Greeks and this means that for every unit that the underlying’s price moves, the option’s price will change by the delta amount. For example, an ATM contract will have a delta of 0.50, an ITM contract will have a value between 0.5 and 1.0 and an OTM contract will have a value between 0.0 and 0.5. So, an ATM and ITM contract will gain value quicker than an OTM contract when the underlying’s price moves favourably.

It is easy to determine how much an option costs as well as the potential gain of an option strategy. The likelihood of trade success may seem difficult to obtain but here is a simple trick: use the option chain’s Greeks. Specifically, the option’s delta will tell you an approximate value for what the market is estimating for this. For example, if a strike for a call option has a delta of 0.32, this means that the market is estimating that this contract has a 32% chance of being in the money on expiration.

You can click on these links to learn more about the strike prices, option chain, option Greeks, moneyness, or other Options topics in our UpLearn course.

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Beautiful post bro. Loved the content and emotions as well, but when it comes to choosing strike price, it’s upto what’s our appetite to loose and risk management. One I was novice i i thinking that coming to stock market and making money is like gambling but due to course of time I realised that it’s not gambling it’s pure game business who runs on probability, if I’m good at probability it will make money gradually as per we get experienced. So first this come first give it some time, our attention and analysis is what makes us an active trader.

Apologies if anything said is irrelevant.

Regards
Vishal Singh

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