Choosing the right option strike price is one of the most crucial decisions to make while options trading. It is basically the price at which you can exercise an options pattern. Besides choosing the expiry date, this is the most crucial part of options trading. In this blog, we will discuss some of the most important things to consider when picking the option strike price. Keep reading!
Things to Know When Choosing the Option Strike Price
Following are some important considerations regarding the selection of option strike price in options trading:
Identify the Right Market
When it comes to trading options, there is a range of markets you can choose from. These include commodities, forex, and indices. Besides, you also need to consider the time horizon for your option. You can either choose monthly or weekly.
2. Choose the Right Options Strategy
The right options strategy will determine how, when, and for what strike price you’ll exercise an options trade. There are several things to consider here, such as how your options are priced, and the difference between purchasing or selling calls and puts.
3. Take Into Account Your Risk Tolerance
Your risk appetite directly affects the option strike price. It is no hidden fact that options markets are highly volatile and you will need to get familiar with the Greeks before starting your trade. The reason behind this is simple, they are among the key factors that affect the value of options. Apart from this, implied volatility also plays a huge role in calculating the risk involved in options trading. Note that implied volatility offers an estimated value of the expected volatility of an option based on the changes in the current price. Implied volatility directly impacts the price you pay for the option’s premium. The higher the implied volatility, the higher will be the premium.
4. Analysis is Very Important
Once you know your risk appetite, you should proceed further by performing some technical as well as fundamental analysis on the market you’re planning to carry out your options trade. This can greatly help in understanding why market prices are the way they are at present. Plus you also get an idea as to whether or not your option trade will result in profit or loss.
5. Choose Your Option Strike Price By Working Out the Options Value
Determining the value of an option is undoubtedly one of the most crucial but difficult parts of options trading. Note that there are two types of option values: time value and intrinsic value.
Intrinsic value is nothing but an inherent value of an options contract. It is calculated as the difference between the strike price of your option and the current price of the asset underlying it. Time value on the other hand is the extra amount of money that a buyer is willing to pay over a certain intrinsic value. Buyers usually do this when they believe that options will see a hike in value before their expiry date.
In a nutshell, intrinsic value comes into the picture only for options that are in the money. This is because the options that are out or at the money don’t have any kind of inherent value associated with them.
Time value, on the other hand, is calculated as the difference between intrinsic value and the option premium. Moreover, the option premium is the sum of time value and intrinsic value.
So, for choosing an options strike price, you need to consider all the factors we have mentioned above. You need to carefully select your strike price after analyzing the volatility of your target market. Once all of these factors are considered, you can start trading your options by opening an account.