Selecting Right Options Strike Price

This item was filled under [ Option Strategies ]

One of the important consideration for options trading is the selection of strike and right strategy.. Lets look at the factors that affect the selection of strike price for SPREAD trade.

Once we have used the technical analysis and form our view about the market direction, we need to start looking at right option strategy selection. This also include the selection of strike price.

Lets say the market is at 4460 level. Our view of the market is bullish and hence we decide to select Bullish Call Spread startegy.

Trade 1= Select 4500 – 4600 call spread. So we buy 4500 Call @139 and sell 4600 Call @ 101. Net cost of spread = 139-101 = 38

Trade 2 = Select 4200 – 4300 call spread. So we buy 4500 Call @281 and sell 4300 Call @ 224. Net cost of spread = 281-224 = 57

Trade 1 can gain the maximum value given by the difference of both strike price i.e 100, This will come when

1) you hold this trade till expiry and

2) market expires above 4600.

If mkt goes above 4600 before expiry, the spread will not be worth 100 because of the time value component of the option.

Max profit potential is 100 – 38 = 62 points.

Compare this with the Trade 2. This spread is already deep in the money. It also has the maximum value of 100. There is very high probability of market closing above 4300 . (Based on the huge built up of Puts at 4300 and 4400 given by option interest at these strike price).. So you have much higher probability of this strike giving you full value of 100 (i.e. giving us the profit of 43 rs) then Trade 1. With each passing day, OTM spreads will have lesser probability of getting into the Green whereas the ITM spread keeps getting more towards dark Green.

The trade-off of both spreads from options traders mindset will be

Trade 1 = 62 rs profit on the risk of 38 but low probability of success

Trade 2 = 43 rs profit on the risk of 57 but much higher probability of success

Another points is important to notice with Spreads is that they are slow moving trade. Ex. in 45-4600 spread to gain 63pts market needs to move 150 points and stay there for next 15 days.

They are ideal for laid back trading but doesn’t give that fast pace action of daytrading NF on 5 min chart. Trading Deep ITM spreads is my favourite strategy for limited risk income generation.

As always, feel free to post your comment / question below.

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One Comment on “Selecting Right Options Strike Price”

  • Sreenivas
    25 November, 2014, 9:07

    Hi Anup,
       It’s always better to have position in ITM contracts as per the above explanation. One clarification: Do I need to execute this type of strategy on the expiry day itself ? becoz we can give enough room for the spread to get better returns. Please clarify….

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