How To Select The Strike Price For Options Trading? | ELM (2024)

FAQs

How To Select The Strike Price For Options Trading? | ELM? ›

A relatively conservative investor might opt for a call option strike price at or below the stock price, while a trader with a high tolerance for risk may prefer a strike price above the stock price. Similarly, a put option strike price at or above the stock price is safer than a strike price below the stock price.

How is the strike price of an option determined? Companies almost always determine the strike price of their stock options based on the fair market value (FMV) of their shares.

The model's formula is derived by multiplying the stock price by the cumulative standard normal probability distribution function. Thereafter, the net present value (NPV) of the strike price multiplied by the cumulative standard normal distribution is subtracted from the resulting value of the previous calculation.

One can compute intrinsic value by calculating the difference between the spot price of associated security and strike price of the said contract. Time value is an additional amount that one is willing to pay over and above the intrinsic value, hoping that contract value may increase as it nears its expiry.

The buyer of a call option seeks to make a profit if and when the price of the underlying asset increases to a price higher than the option strike price.

A put option is said to be in the money when the strike price is higher than the underlying security's market price. Investors commonly use put options as downside protection, which cuts or prevents a drop in value. Puts may give investors short market exposure with limited risk if the underlying asset's price rises.

When the stock trades at the strike price, the call option is “at the money.” If the stock trades below the strike price, the call is “out of the money” and the option expires worthless. Then the call seller keeps the premium paid for the call while the buyer loses the entire investment.

Call options are “in the money” when the stock price is above the strike price at expiration. The call owner can exercise the option, putting up cash to buy the stock at the strike price. Or the owner can simply sell the option at its fair market value to another buyer before it expires.

An average strike option is a type of option where the strike price depends on the average price of the underlying asset over a specified period of time. The payoff is the difference between the price of the underlying at expiry and the average price (strike). Average strike options are also known as Asian options.

This rule suggests that a stock's price tends to move in cycles, with the first 3 days after a major event often showing the most significant price change. Then, there's usually a period of around 30 days where the stock's price stabilizes or corrects before potentially starting a new cycle [1].

Do options automatically exercise at strike price? ›

Stock options that are in-the-money at the time of expiration will be automatically exercised. For puts, your options are considered in-the-money if the stock price is trading below the strike price. Conversely, call options are considered in-the-money when the stock price is trading above the strike price.

When the stock price equals the strike price, the option contract has zero intrinsic value and is at the money. Therefore, there is really no reason to exercise the contract when it can be bought in the market for the same price. The option contract is not exercised and expires worthless.

Advantages of In the Money Call Options

Once a call option goes into the money, it is possible to exercise the option to buy a security for less than the current market price.

In-the-money (ITM) options: When the strike price of an option is favourable compared to the current market price, it is considered in-the-money. For call options, this means the strike price is lower than the market price, making it more profitable to exercise.

The closer the strike prices are to the underlying's price, the more debit will be paid, but the probability is higher that the option will finish in-the-money. The larger the spread width between the long call and the short short, the more premium will be paid, and the maximum potential profit will be higher.

Straddle is considered one of the best Option Trading Strategies for Indian Market. A Long Straddle is possibly one of the easiest market-neutral trading strategies to execute. The direction of the market's movement after it has been applied has no bearing on profit and loss.