Choosing the right strike price when trading options is just as important as the direction of the market. The right strike price can mean the difference between trading success and trading failure. The more often you pick the right strike prices, the higher your odds of success over the long term will be.
High delta for quick market moves
When buying options you should choose 1 of 2 types of strike prices.
Buying closer-to-the-money options gives you a higher delta, which means your options will respond to every dollar movement of underlying stock sooner and stronger. Likewise, buying at-the-money options (or options that are lower/higher than the actual stock prices) reduces your risk that the stock has to make a small move for your options to be in-the-money.
Can you guess both the direction and timing?
As an option buyer you have to not only predict the direction of the market (put/call) but also the magnitude of the move. How fast will the market get to your target? Will it take 3 months or 6 months?
In the world of options trading just 1 day can make the difference between profits and losses. If you buy an option at the strike that you think the underlying security will move to, you’re likely to lose money because you paid premium for the options time value. If your right about the direction but dead wrong about the timing – you lose.
Deep OTM options are like lottery tickets
Deep-out-of-the-money strikes appear attractive for the “novice” options trader because of the low absolute dollar value of the options. But remember that these options have a low dollar value because it’s highly unlikely they’ll ever be in-the-money.
I relate this to buying a lottery ticket. Sure it’s only $1 but how likely are you to ever make money on that lottery ticket? Last time I checked you were more likely to get hit by lightning TWICE in the SAME day!
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