Picking your options’ strike price boils down to a couple of key decisions, such as: What price do you think the underlying stock will move to over a certain period of time and what price are you willing to pay or receive for buying or selling an options contract? To help answer these questions, consider option greeks, and a probability calculator.
The basics: What is the strike price?
For call options, the strike price is the price at which an underlying stock can be bought. For put options, the strike price is the price at which shares can be sold.
For instance, one XYZ 50 call option would grant the owner the right to buy 100 shares of XYZ stock at $50, regardless of what the current market price is. In this example, $50 is the strike price (this can also be known as the exercise price), XYZ is the stock, and call is the type of option (as opposed to a put, which grants the buyer the right to sell the stock at a predetermined price).
Assuming a stock were trading at $60, if you had purchased a call option on that stock with a strike price of $50, you would be able to exercise that option and purchase the stock at $50, even though the stock was trading at $60.
Suppose you purchased one XYZ 50 call option for $3 (i.e., the premium or cost of the option), and exercised it after the underlying stock had risen to $60. Your profit, before taxes and transaction costs, would be $700. This is calculated as the $60 stock price minus the $50 option strike price minus the $3 purchase price, times 100 (because each options contract covers 100 shares of the underlying stock).
But when you are deciding which option to buy, how are you to know if the $50 strike price was the best one for your strategy? If the stock was trading at $50 at the time you were deciding to buy a call option, there might be options with strike prices of 30, 35, 40, 45, 50, 55, 60, 65, 70, and more. Fortunately, there are tools to help you make this critical decision.
While choosing the “right” strike price does not ensure that you will make a profit, it can increase your chances of success. One tool that can help you get set up in the right lane with the optimal strike price is the option’s greeks.
Greeks are mathematical calculations designed to measure the impact of various factors—such as volatility and the time to expiration, on the price behavior of options. One greek in particular that can help you pick the strike price is delta, which measures an option’s sensitivity to the underlying stock price.
Delta can be used in several ways when constructing your options strategy. When it comes to selecting the strike price, here’s how you might use delta.
Delta ranges from -1 to +1. If the delta is 0.70 for a specific options contract, for instance, each $1 move by the underlying stock is anticipated to result in a $0.70 move in the options price. A delta of 0.70 also implies a 70% probability that the option will be in the money at expiration. Intuitively, the greater the probability suggested by delta, the more expensive the option will be. Alternatively, the lower the probability suggested by delta, the less expensive the option will be.
To find the delta for an options contract, look at the options chain for a particular stock.
If you want a more precise calculation of probability than that provided by delta, Fidelity’s probability calculator can help you be in a better position to choose the right strike price for your strategy. The benefit of the probability calculator is that it may help determine the likelihood of an underlying stock or index trading above, below, or between certain price targets on a specified date.
Using this information, you may be able to enhance your profitability by selecting a strike price with the best potential to capitalize on the probability of the underlying stock or index reaching a certain price.
You can access this tool by going to the options research page on Fidelity.com, selecting the Quotes and Tools tab (login required), and then entering a ticker symbol of your choosing (e.g., GOOG for Google). The probability calculator enables you to adjust the stock price target, target date, and volatility parameters based on your own analysis to determine the probability of the underlying stock or index reaching a certain price. The calculator also allows you to enter different strike prices to determine the probability of a successful option strategy.
A few more tips
Of course, there are other ways to choose the strike price to buy or sell. Some traders use additional options statistics—including implied volatility and historical volatility2, which are available on Fidelity.com and Active Trader Pro®.
“When trading options, you are essentially trading implied volatility as well,” notes Colin Songer, a trading manager on Fidelity’s strategy desk. “Having your own outlook on implied volatility can help your trade potentially be more successful.” Moreover, there are a number of factors that can influence the strike price decision. Among them:
- Time: Holding all else equal, a contract with a longer life implies a greater probability that the option will be in the money before expiration, but it will also cost more than a similar option with less time until expiration.
- Liquidity: You almost always want to look for options that are heavily traded and have small bid-ask spreads if you want to focus on reducing your trading costs.
- Moneyness: In-the-money options are relatively more expensive than out-of-the-money options.3
When making your next options trade, consider option greeks and a probability calculator among the tools you can use to aim for the best strike.
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