How To Choose The Right Strike Price For Your Options Trading System
Master Strike Price Selection for Maximum Profits
You have a trading system telling you when to enter and exit options trades.
But do you know how to pick the right strike price for your contracts?
The strike price is what you can buy or sell the underlying asset for when exercising your option. It hugely impacts your profitability as a trader.
Not all strike prices are equal. Based on the relationship between strike price and asset price, contracts are classified as:
in-the-money,
out-of-the-money, or
at-the-money.
Each has advantages and disadvantages. Knowing how to use them correctly can massively boost returns.
Unfortunately, many traders lack a clear rule for selecting the right strike price. They either choose randomly or use vague guidelines ill-suited to their system. This leads to poor returns, missed opportunities, and unnecessary losses.
The main reason traders don't have a clear strike price rule is not understanding how it affects their risk-reward ratio and probability of success.
Some other reasons are:
Not analyzing market conditions and volatility.
Not calculating intrinsic and extrinsic value.
Not adjusting strike price based on market changes.
Not diversifying strike price across trades.
Not optimizing strike price for strategy types.
But don't worry. In this newsletter, I'll show you how to overcome these challenges and choose the right strike price for your system.
You'll discover:
What in-the-money options are,
How out-of-the-money options work, and
When to use at-the-money options.
By the end, you'll select the best strike prices for consistent profits.
Let's get started.
What are in-the-money options?
In-the-money options have intrinsic value. Meaning their value will not go to 0 on the expiration date.
For calls, this means the strike price is below the underlying price. For puts, the strike price is above the underlying price.
For example, suppose today is the expiration date, and you buy a call on Nifty with a 15,000 strike, and Nifty closes at 15,500; your option is in-the-money by 500 points. This means your option contract will expire at 500 rupees.
In-the-money options have higher premiums, reflecting their greater chance of expiring with positive value.
In-the-money options are ideal for traders who:
Have strong directional bias and want to capture the movement of the underlying asset.
Want to hedge their existing positions or lock in profits.
How do out-of-the-money options work?
Out-of-the-money options lack intrinsic value. Meaning their value will go to 0 on the expiration date.
For calls, the strike price is above the asset price. For puts, the strike price is below the asset price.
For example, suppose today is the expiration date, and you buy a call on Nifty with a 16,000 strike, and Nifty closes at 15,500; your option is out-of-the-money by 500 points. This means your option contract will expire at 0 rupees.
Out-of-the-money options have lower premiums due to a lower chance of expiring with positive value.
Out-of-the-money options are ideal for traders who:
Expect a large move in the underlying asset's price and want to leverage their capital.
Want to speculate on volatility or sell premium.
When should you use at-the-money options?
At-the-money options lack intrinsic value but have minimal extrinsic value. Meaning that they barely break even on the expiration date.
For calls and puts, the strike price equals the asset price.
For example, suppose today is the expiration date, and you buy a call on Nifty with a 15,500 strike, and Nifty closes at 15,502; your option contract will expire at 2 rupees theoretically.
At-the-money premiums mostly reflect extrinsic value. They have a 50% chance of expiring profitably.
At-the-money options are ideal for traders who:
Have a neutral or slightly bullish or bearish outlook on the underlying asset's price and want to benefit from time decay or small price movements.
Want to create delta-neutral or market-neutral strategies.
But what if the option type changes as the asset price moves?
For example, suppose you buy an in-the-money call, and the asset price drops below the strike price. In that case, your option becomes out-of-the-money, losing intrinsic value.
To deal with this, have a clear exit plan with stop-loss and take-profit orders. Monitor conditions and volatility, adjusting positions if needed.
For example, buying an in-the-money call on Nifty with a 15,000 strike at 15,500 set a 14,900 stop-loss and 16,000 profit-target. This limits downside risk while locking in the upside.
Alternatively, use strategies like spreads to hedge or boost returns if positions move against you. The key is having a systemized approach and following your trading rules.
By doing this, you can select the right strike price and achieve consistent profits.
I hope you enjoyed this newsletter and found it valuable. If you did, please share it with your friends and fellow traders who might benefit from it.
If you have any questions or comments, please reply to this email. I'd love to hear from you.
See you next week! 🙂
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