How To Choose The Best Strike Price For Options Trading

Choosing the “best” strike price can be very subjective because it can be interpreted differently by different people.

And you will never know the best strike price until the market has moved.

So how do you know which strike price should you choose?

And which strike price will give you the best chance of the trade working out?

The “Best” Strike Price Is Subjective

It’s hard to really know which strike price is the best until the market has moved.

Let’s say, for example, you’re bullish on the market and want to trade the Short Put.

And let’s say you are given three strike prices to sell a Put Option at.

You can sell a Put with the strike price of 100.

You can sell a Put with the strike price of 92.

Or, you can sell a Put with the strike price of 84.

Which do you think is the “best” strike price?

Which strike price would you choose?

Well, the problem is that there’s no right answer.

For example, if the market bounced up from here and never touched the 100 strike price, then the Short Put with the strike price of 100 would be the “best” because you’d be able to get the most premium.

But what if the market went down to $96 and stayed there till the Short Put’s expiration?

Then the strike price of 92 would be the “best” strike price.

Similarly, what if the market had gone down to $88 and stayed there till the Short Put expires?

Then the “best” strike price would be at 82.

As you can see, the “best” strike price will never be known until the market has moved.

So if that’s the case, how can we determine which strike price should we choose for our Option strategies?

A Good Balance of High Win-Rate And Premium

In my opinion, the “best” strike price would be a good balance of having a high probability of profit and also a good enough premium.

So what is considered a “high probability of profit” and “good premium”?

For this, we need to understand delta a little better.

While delta measures the rate of change of the Option’s pricing based on a $1 move up or down in the underlying security, it can also be used as a quick way to determine the probability of a strike price being In-The-Money (ITM) at expiration.

For example, a strike price with 20 deltas would mean that there’s an approximately 20 percent chance of the strike price being ITM at expiration.

This also means there’s an 80 percent chance of being profitable,

Similarly, a strike price with 10 deltas would mean there’s an approximately 10 percent chance of the strike price being ITM at expiration.

Which also means there’s a 90 percent chance of being profitable.

If you were to see the Options Chain above, you will see the delta at the side.

The closer the strike price is to the current market price, the higher the delta.

The further away the strike price from the current market price, the lower the delta.

This means that the strike prices that are further away from the current market price will have a higher win rate than strike prices that are nearer to the current market price.

So based on the Options Chain above, which strike price should we choose as the most optimal strike price?

For this, we need to understand “Expected Move”.

The Expected Move is the amount a stock is expected to either go up or down from its current price by a certain time based on its current Implied Volatility (IV).

Basically, it’s the range that the stock is expected to move by a given timeframe (i.e. the next 30 days).

So how do you determine what is the Expected Move of a stock?

A simple way is by choosing the 16 deltas strike price.

In the Options Chain above, this would be the 86 strike price.

With 16 deltas, the theoretical win rate is 84%.

However, in practice, the win rate is actually higher.

Below is a table done by the TastyTrade team where they studied the theoretical win rate versus the actual win rate:

The table above is based on a Short Strangle position where the strike price is at the Expected Move.

By looking at the table above, we can see that the theoretical win rate is 68%.

However, the actual win rate is from 71% to 85%.

Why is this so?

That’s because historically, the IV has always overstated the Realized Volatility (RV).

That means the actual movement range of the market is smaller than what the theory suggest.

For example, theory might suggest that XYZ stock might move $20 in the next 30 days.

But the actual movement is much lesser than $20.

Which means that the market will stay within the strike price more often than it exceeds it.

Hence, the actual win rate is higher than theoretical win rate.

How To Choose The Best Option Strike Price

So now that we know about the Expected Move, how do we select the best Option strike price?

If you want to have a consistent income when selling Options…

And you want your strike price to have a lesser chance of getting breached…

Then you want to choose the strike price that is around 16 deltas (anywhere from 15 deltas to 30 deltas would be a good range).

Now, you might be asking, “What about choosing strike prices that have less than 16 deltas?”

There are two problems with selecting strike prices with less than 16 deltas.

The first problem is that there may not be sufficient premium.

As you go further away from the market, while your win rate increases, your premium starts dropping off significantly.

The second problem is that when the occasional outlier loss occurs, you may not have made enough to cover that loss.

That’s because the premium is disproportionate to the win rate.

That means that while the win rate may increase by one percent, the premium to be made becomes exponentially lesser.

Hence, it’s important to have a good balance of premium and win rate when deciding which strike price to go for.

That is why we opt to go for the strike price that’s around 16 deltas to have sufficient premium, and also to have a decent win rate.

And that’s how you select the best Option strike price.