How to select right strike price in Options trading

Options trading seems very complex to a lot of traders at the beginning. However, if we put a process to it, there is a method to this madness as well. With about 40 Options for each expiry and 3 expiries available for trading, any stock would have at least 120 choices at any time.

For us to understand this, we need to adopt a method of omission. This will help in reducing these 120 strikes into just 3-4 strikes. After that we can easily come to a strike price based on simple process of selection.

We will reduce the Options down via method of omission in 3 easy steps.

1. View Based reduction of 50 percent of the Chain

We know which side of the market we are going to place the trade. Option Chain is divided into Calls and Puts. Reduce the 50 percent of the chain by omitting the Calls if the view is Bearish or by omitting the Puts if the view is Bullish.

2. Stay in the current

In this step, we will give most important to the options that are most sensitive to the movement and least expensive. Closest to expiry are the Options that are least expensive. Having said that, we may feel the move may come on Friday. Here if Thursday is the expiry we are better off choosing the next expiry. In all other cases closest expiry date option is what we choose.

3. Keep whatever is close to you

This is the final step. Going with the same sensitivity theory, we do not want to choose strike that is too far up or too far down. This is because either one of those will have super low sensitivity or are super expensive and very illiquid. Either way the strike selected will not work for us.

Now we are left with Single Expiry + Call/Put + 4 Strikes (2 above the price and 2 below the price).

Process from here on is also very simple. Before that let us understand groups of strikes and few characteristics.

Group 1 Higher Strike Calls / Lower Strike Puts =

• Less Expensive

• Little Less Sensitive

Group 2 Lower Strike Calls/ Higher Strike Puts =

• More Expensive

• Little More Sensitive

Group 3 Calls and Puts close to Current Market Price=

• Best of Both worlds

Finally, the process is to assess the view that we have and match it to numbers 1,2 or 3.

1. This group strikes are economical best suited for against the trend trades or reversals. Wherever the confidence in the view is the least choose Group 1 strikes. In case if the Option hits stop loss, the loss will be low. In case there is a big move against us, and we do not even get to trigger stoploss, we do not lose big.

2. Group 2 strikes are selected when the view is very confident. One wants to bet big, group 2 is big bet. Group 2 Options are more expensive and less sensitive to time but more sensitive to underlying.

3. For every other time choose Group 3