How to select the best strike price option for buying

Have you ever wondered how to navigate the intricate world of selecting the perfect strike price for your options trading? It's a question that often gets overlooked, but it can be the key to avoiding the dreaded premium erosion that plagues many option buyers.

In this blog, we'll delve into the art of strike price selection and how it can make or break your options trading strategy.

Choosing the right option strike, balancing risk and reward, is a pivotal decision when venturing into option trading. It's the fine line that separates profitable ventures from loss-making ones. Unfortunately, strike selection is where many retail options traders stumble and end up draining their funds.

Selecting a strike price stands as a pivotal aspect of options trading. Within this discussion, you will not only grasp the concept of a strike price but also uncover the art of selecting the optimal strike price aligned with your options buying strategy.

Option buyers can circumvent premium eating by selecting suitable option strikes that give them a good amount in return. Keeping this problem in mind, I have come up with some points that might help you in your decision to buy an option.
Here are some points that you need to think about when you select an option strike for buying.

Check the Moneyness of the Option:
The first thing that an option buyer should keep in mind while buying is the Moneyness of the option. It is an important choice that you need to make when it comes to option buying, whether you go for an ITM option, ATM option or an OTM option. Based on the intrinsic value, we categorize the Moneyness of an Option in ITM, ATM and OTM. If you are interested to learn the details about Moneyness, you can check here.
OI Positions in JSW Steel

For example, if JSW Steel is quoting around Rs.240, and if you are expecting a 10% decrease in price due to some global sell-off, then you need to buy the JSW Steel put option with a strike price of 220 or 215. Only these strikes can give you the best intrinsic value or Moneyness. On the contrary, if you choose to buy a 180 put option just because the premium is negligible, then you are unlikely to make any money. Hence the selection of the strike price is critical. 180 is a deep OTM with almost zero Moneyness.
Change In OI in JSW Steel

Time to Expire

Being Out of the Money (OTM) or Deep OTM options doesn't mean they can't be profitable. In fact, they often yield a higher return on investment compared to other strikes. However, it's crucial to consider the option's time to expiration. If you're at the start of a series and anticipate a 10% downside move within a day or two, OTM or Deep OTM options are a sensible choice.

But what if the expected move doesn't materialize within the expected timeframe and takes 15 trading days instead? With half of the series elapsed, your chances of profiting from these strikes diminish by at least 50%. Each passing day reduces your profit potential.

Consider another scenario, the move comes on the expiry day, and your strike will mislay its entire moneyness for sure.
So, you can trade according to this:

1. OTM or deep OTM- Starting off the series
2. ATM - After 10 days of you can deal with ATM
3. ITM - After 15 days you should move towards ATM or ITM
4. Deep ITM - You are trading expiry, it is advisable to trade deep ITM.

Check The Liquidity of the Strike
When buying options, two critical considerations are the premium price and strike liquidity. First, determine your budget and the premium you're willing to invest. Once you've chosen a strike within your budget, assess its liquidity.

Liquidity refers to whether there's active trading, volume, or open interest at the selected strike. Sufficient volume and open interest are vital; otherwise, you risk getting stuck. If the strike lacks liquidity, consider expanding your budget or exploring alternatives. It's generally advisable to stick with At-the-Money (ATM) and In-the-Money (ITM) strikes, as they tend to be more liquid. You can assess liquidity using the Option Chain available on NSE.

ATM and ITM are always advisable as they are liquid.
JublFood OI Positions

 In 1400 and 1450 calls in the above image, you can spot little open interest and also in 1850 and 1900 puts have little Open Interest, indicating less liquidity.

Find the Trading Range

You can assess liquidity by examining the trading range of stocks in the Option Chain. This range is determined by identifying the strike with the highest Open Interest on the Call side as well as the highest Open Interest on the Put side. Any strike within this trading range is considered sufficiently liquid for purchase.

SBIN OI Positions

The highest Open Interest in call options signifies the strongest resistance level, while the highest Open Interest in put options indicates robust support. When examining the trading range, it's crucial to avoid an excessively narrow range that can stifle the stock's movement. A narrow range can potentially lead to losses due to consolidation.

Highest Open Interest at call indicates the highest resistance and highest Open Interest at Put indicates the Highest support.

The trading range in SBIN according to the above chart is 240 to 300. You can spot the liquidity in the range strikes.

Is Pivot Level Shifted?

In every option chain, there exists a strike with substantial open interest on both sides, encompassing both puts and calls. This unique strike, which I like to refer to as the "Pivot level," symbolizes a battleground where neither bulls nor bears are willing to relinquish control easily.

When the Pivot level moves upwards within the options chain, it signals that bears are taking charge of the market. Conversely, a downward shift in the Pivot level indicates bullish dominance. The upward movement of the Pivot suggests a looming downtrend, while a downward shift suggests the opposite.

For instance, let's revisit the SBIN Open Interest (OI) chart. Take a closer look at the 260 strike, where both Call and Put Open Interest are nearly identical. This level can be aptly designated as the Pivot level, representing a balance of power between buyers and sellers.
Check Action in OI Change

Recognizing a pivot shift is a crucial event for trend analysis, and it can be achieved by closely monitoring changes in Open Interest (OI). During a downtrend, you'll observe OI shifting towards the put side within the option chain, with a decrease in call strike OI.

Action in OTM Strikes

Typically, ahead of positive announcements, you may observe increased activity in Open Interest for Out-of-the-Money (OTM) and Deep OTM call options. Conversely, significant accumulation in Deep OTM put options suggests the presence of potentially negative news. This pattern often precedes important stock-related events.

The Bottom Line

Evaluating moneyness, time to expiration, and pivot level shifts are valuable tools to consider when purchasing options. These factors can also help ensure liquidity in the underlying stocks. Additionally, option buyers commonly assess the option Greeks.

How do you select a strike for buying? Write us in the comment.
Questions hovering in the mind? Hit the Comment Box now. And bless this Post with social media share.

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