Strike Price & Expiration Selection
The strike price and expiration date are the two most important choices when trading options. Let's understand how to select them wisely.
These Choices Determine:
- How much risk you're taking
- How much you can profit
- How fast your option loses value
Strike Price Fundamentals
The strike price is the price at which you can buy (call) or sell (put) the underlying stock.
It affects:
- How much you pay for the option (premium cost)
- The probability of making a profit
- Intrinsic vs. extrinsic value of the option
Key Takeaway: The further the strike price is from the current stock price, the cheaper the option but the lower the probability of profit.
Moneyness: ITM, ATM, and OTM
Example: If Apple (AAPL) is trading at $150:
- A $140 Call is ITM
- A $150 Call is ATM
- A $160 Call is OTM
Key Takeaway:
- ITM options are more expensive but have higher chances of making money
- OTM options are cheaper but risk expiring worthless
Choosing the Right Strike Price
Consider these factors when selecting a strike price:
- Your market outlook (bullish/bearish)
- Risk tolerance and account size
- Time until expiration
- Implied volatility levels
Example: Choosing a Call Option Strike Price
Stock: Tesla (TSLA) at $200
You expect TSLA to rise in a month.
Key Takeaway:
- ITM is safer but expensive
- OTM is riskier but cheaper
Understanding Expiration
The expiration date is when the option contract ceases to exist.
After expiration, the option is either exercised or expires worthless.
Why Expiration Matters:
- The closer to expiration, the faster Theta Decay (loss of time value)
- Shorter expirations have higher risk but higher profit potential
- Longer expirations are safer but cost more
Types of Expirations
Key Takeaway:
- Short-term traders use weeklies for fast profits
- Long-term investors use LEAPS for hedging
Exercise Style Differences
- American options can be exercised any time before expiration
- European options can only be exercised at expiration
- Most stock options are American style
- Index options are typically European style
Time Decay Impact
- Theta accelerates as expiration approaches
- ITM options lose value slower than OTM options
Example: How Time Decay Impacts Option Value
Key Takeaway: The closer you are to expiration, the faster your option loses value.
Important Expiration Considerations
Before trading options, consider:
- Time Decay: Options lose value faster near expiration
- Liquidity: Closer expirations have more trading volume
- Assignment Risk: ITM options may be exercised early
- Pin Risk: Stock price often gravitates to key strike prices near expiration