Picking the Magic

Strike Price
Ernie Zerenner
President
Power Financial Group, Inc.
PowerOptions – www.poweropt.com

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 Introduction
 Option investing has several degrees of
freedom more than equity investing:
 Strike price
 Time decay
 Month selection

 This talk will concentrate on the choice of

the strike price for both buying and selling
strategies.

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Basic Covered Call
Calculations
Using the option premium for each
strike price, our option chain calculates:
 % Downside Protection
 % if Unchanged

 % if Assigned

 % Probability the Stock Price will be above

the Strike Price

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Observations on Option
Chain
 Observe the general trend in pricing as
the strike price increases:
 Option premium declines
 % Downside protection declines

 % if Unchanged is highest ATM

 % If Assigned increases

 % Probability Above declines

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 XYZ ($81) with 44
days left
Strike Option %DnSd % if % if % Prob.
Price Prem. Protect. Unchg. Assign. Above

75 $6.70 8% 1% 1% 90%
ITM

80 $2.75 3% 2% 2% 60%
ATM/ITM

85 $0.65 1% 1% 6% 18%
OTM

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How to interpret the
data
 High returns comes with a “risk”
 Highest return (if unchg) is ATM
 Greatest safety is ITM
 Greatest potential gain is OTM
 The more the potential gain then the
lower the possibility of success based
on probability

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 Back to the point
in Question:
What strike?
 It all depends on your own risk reward profile:
 Looking at the last 2 columns of % if Assigned
and % Prob. Above as a pair
 The lowest return of 1% has a 90% chance of
happening (highest % Probability Above)
 The highest return of 6% has only an 18% chance

of happening (lowest % Probability Above)

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 What Strike based on
Risk
Looking at the % Downside Protection and the % If
Assigned columns as a pair:
 The highest downside protection has the lowest
return, but the stock price can fall and still win
 The highest return is possible at the highest strike
price, but it has the lowest downside protection
 To achieve the highest returns requires the stock
to rise in price. If it does not rise the return is
lowest of all.
 The highest strike price is a play on stock
appreciation not covered call income

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 Real Life
Example
 Retired and looking for income

 Preservation of capital is more important

than speculative gains

 Want a better return than a CD or a Bond

 Want to reduce the volatility of my holdings

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Some of My
choices
 Case 1 – Already own stock and
want to earn income.

 Case 2 – Have cash and want to

do a buy / write to generate income

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Case 1 – Already own
 Use strikes ATM or slightly OTM
 Want to avoid being assigned therefore
must roll up and out if ITM.
 Must watch dividend exposure to avoid
early assignment.
 Actively manage by buying back the
option if it declines and rolling down

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 Case 2 – Buy /
Write
 Always go ITM
 Sacrifice large returns for safety
 As a rule of thumb limit annual gains to 20 to
30% Max.
 Reduce the excess gain by going further ITM.
 Actively manage the position by liquidating
once 70 to 80% achieved.

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 Summary on CC
Strikes
 It’s all about risk / reward

 Each situation is different, but each strike

has a set of characteristics, which can be
tailored to your circumstances

 Be sure you have the tools and calculations

available to make the smart choices

Copyright Power Financial Group http://www.poweropt.com/oxp2/

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That was selling
options
 Now we discuss buying options
 Investors tend to pick the wrong strike price!
 Choices based on number of contracts?
 Go deep OTM for cheap options

 Go ITM for high delta and low time premium

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Picking a Strike when
Buying
 We need to decide: Which month & strike.
 How much time premium should we buy
 The more ITM the more it costs
 More time costs more money
 This all effects the number of buy contracts
 But, where is the best return?

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Tool to Maximize
Returns
 Assumptions in developing the tool
 Forecast the stock price
 Time frame for the move

 How much will you invest

 Will volatility change

 Based on these inputs the best return can

be calculated for every possible strike
price

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Input Example:

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Output Example:

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 Summary of
Buying
 Make a forecast for the stock
 Determine the time the move will take
 How much you want to invest
 Then use a tool to calculate the best strike
to use based on returns.

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http://www.poweropt.
com/oxp2/
 Use the above URL for a 30 day FREE Trial
 Toll free help using the site
 Try these techniques by paper trading
 One-click trading for optionsXpress clients
 877-992-7971 (toll-free)

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Tomorrow’s
presentation
Tools and Software

 How to Find Option Trades with

SmartSearchXL

 4PM Friday May 5th

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