I am somewhat of a newbie. I only buy SPY calls and puts, and I am quite confused about how to pick the right strike price. From a theoretical point of view, if you wanted to buy $10,000 worth of Oct 2011 SPY calls, I think that you would take the current price of each strike, the commission you would pay to buy and sell the number of shares of each strike that equal $10,000 and then, using the Delta, compute your potential profit on a $1 move up in the underlying SPY price to see which strike price has the most profit potential from a $1 move. But, what I am finding is that the actual moves of prices at different strikes is very different from the Delta for each strike price. Take for example the $120 Oct 2011 SPY call and put. The call has a Delta of .56 but, with a .7 move in the SPY yesterday, it only moved up .23 (instead of .32 as the Delta would indicate), and the put has a Delta of -.43 and it moved down .56 or more than the Delta would have predicted for a $1 move in SPY (when there was actually a .7 move). And to make matter even more confusing (at least for me), the $130 Oct 2011 SPY call moved DOWN .03 with a detla of .26 on a day when the SPY was UP .7. The most profitable strike yesterday was the $119 Oct 2011 call, but I can see no apparent reason (except possibly that it had the highest volume) why it was the best performing. So, bottom line, how do I pick the best strike price taking into account commissions? Thanks in advance for any help.
Picking the right strike price
- Thread starter LegalEalges
- Start date
Thanks, rmorse. While I am interesed in knowing if yesterday's price action was unusual/cuased by a particular event, I am even more interested in hearing any thoughts on how to pick the strike price that is likely to be the most profitable. I suppose, in a theoretical sense, it should not matter what strike price you choose, but, in actual trading, it certainly seems to matter.
An option's value is determined by several factors:
- price of the underlying
- strike price
- time to expiration
- implied volatility
- dividends
- interest rates
You have to consider all the "greeks" and even then, understand that they can change by the minute. If you're looking to trade based mainly on intrinsic value, you might want to focus on deep-ITM options.
- price of the underlying
- strike price
- time to expiration
- implied volatility
- dividends
- interest rates
You have to consider all the "greeks" and even then, understand that they can change by the minute. If you're looking to trade based mainly on intrinsic value, you might want to focus on deep-ITM options.
I think you're a bit lost in the weeds 
Forget yesterday because for options, ex-div is a quarterly anomaly. The short answer is that in a perfect world where all strikes have the same IV, you take your position, you get a one pt move immediately and IV remains the same, then the further OTM, the larger the gain. That's because of the leverage of owning more OTM calls - the higher number of calls owned outweighs the smaller gain per call as strikes increase.
In the real world:
- all strikes do not have the same IV hence premium varies
- the deeper the strike is ITM, the wider the spread (more slippage)
- IV not only fluctuates throughout the day but the IV of some strikes may
briefly change more than another
- not all moves occur immediately and then time decay becomes a factor
- previous day last price issues (more of a problem with less liquid issues) may cause a skewed perception gain (was it at the bid, asked or possibly an outlier fill?)
- the greater effect of commissions on larger OTM positions
With all of this going on it's really impossibile to extrapolate the best strike from a day to day option chain each of whose components are a moving target.
For short term trading, I'd focus more on finding the move, grabbing a quick profit and not worrying about the nickels and dimes of which strike would have been the ideal choice. Strike selection is important but more in terms of your timing and size of move obtained versus optimal returns.
Forget yesterday because for options, ex-div is a quarterly anomaly. The short answer is that in a perfect world where all strikes have the same IV, you take your position, you get a one pt move immediately and IV remains the same, then the further OTM, the larger the gain. That's because of the leverage of owning more OTM calls - the higher number of calls owned outweighs the smaller gain per call as strikes increase.
In the real world:
- all strikes do not have the same IV hence premium varies
- the deeper the strike is ITM, the wider the spread (more slippage)
- IV not only fluctuates throughout the day but the IV of some strikes may
briefly change more than another
- not all moves occur immediately and then time decay becomes a factor
- previous day last price issues (more of a problem with less liquid issues) may cause a skewed perception gain (was it at the bid, asked or possibly an outlier fill?)
- the greater effect of commissions on larger OTM positions
With all of this going on it's really impossibile to extrapolate the best strike from a day to day option chain each of whose components are a moving target.
For short term trading, I'd focus more on finding the move, grabbing a quick profit and not worrying about the nickels and dimes of which strike would have been the ideal choice. Strike selection is important but more in terms of your timing and size of move obtained versus optimal returns.
rmorse
Sponsor
You're looking for a simple response to your question, but there is none. You're looking at the issue backwards. You can't look for the "best" strike to trade. You have to come up with a strategy first, then look for the best month and strike or combination of months and strikes to accomplish your strategy. Within that decision is looking at current implied vols and skew to balance risk/reward.
+1. the order you decide to structure you trade is important. also as the quote above mentions iv and choosing strategy, for ex. is iv is high you and you're bullish you might want to buy a call spread or short a put spread to take advantage of the high iv instead of just buying straight calls b/c iv will get crushed if the market goes up by a decent amount which can offset any instrinsic value gains.