How to Choose the Perfect Option Strike Price

The strike price—also known as the exercise price—is the predetermined price at which a put or call option can be exercised. Selecting the optimal strike price is one of three critical decisions investors must make when trading options, alongside determining the expiration timeframe and setting a stop limit order.

Your choice of strike price fundamentally shapes how your option trade will perform. Successful selection requires analyzing multiple scenarios, calculating potential profits and losses at various price points by expiration day. This analysis forms the foundation of your options strategy.

Remember that overexposure to a single trade or asset creates vulnerability to significant, unexpected losses. Implementing a disciplined position sizing strategy is essential for capital preservation and long-term trading success.

Pick Your Option Strategy

Begin by identifying a suitable stock for your options trade through comprehensive analysis. Evaluate the company's financial health, examine current and projected sector conditions, and assess overall market trends. This thorough analysis should provide clear direction on the stock's probable price movement.

Based on your directional outlook, decide whether to buy calls or write puts. Then, select your strike price by carefully balancing your risk tolerance against your desired risk/reward profile—a decision that will significantly impact your trading outcomes.

Determine Your Risk Tolerance

Your risk tolerance will guide whether you select an in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM) option based on your stock price projections.

ITM options exhibit higher sensitivity to the underlying stock's price movements—known as option delta. An ITM call will appreciate more significantly than ATM or OTM alternatives if the stock rises. However, this higher delta is a double-edged sword; the ITM option will also decline more substantially if the underlying stock falls.

ITM calls carry higher initial value but lower risk. Conversely, OTM calls represent the highest risk, particularly as expiration approaches. If held through expiration, OTM calls expire worthless if the stock price doesn't exceed the strike price.

Weigh Your Risk-Reward Payoff

Your risk-reward assessment balances capital at risk against profit targets. While ITM calls present lower risk than OTM alternatives, they command higher premiums. For traders seeking to minimize capital exposure while maintaining upside potential, OTM calls may prove more attractive despite their higher risk profile.

OTM calls can deliver substantially higher percentage returns than ITM calls if the stock surges beyond the strike price. However, this comes with a significantly lower probability of success. You invest less capital in OTM calls, but face higher odds of losing your entire investment compared to ITM positions.

Conservative investors typically gravitate toward ITM or ATM calls, while those with higher risk tolerance may prefer OTM options. Calculate potential gains and losses at various expiration scenarios to determine which approach best aligns with your trading objectives.

Strike Price Selection Examples

General Electric, once a cornerstone of many North American portfolios, provides an instructive example. Consider a scenario where GE's stock recovered from a multi-year decline, gaining 33.5% to close at $27.20 in January.

Let's examine March options for that year, using the last trading prices from January and ignoring bid-ask spreads for simplicity.

The prices of GE's March puts and calls are presented in Tables 1 and 3 below. We'll analyze strike price selection for three fundamental options strategies—buying calls, buying puts, and writing covered calls—through the lens of two investors with contrasting risk profiles: Conservative Carla and Risky Rick.

Case 1: Buying a Call

Both Carla and Rick maintain bullish outlooks on GE and are interested in purchasing March call options.

Table 1: GE March Calls

 

 

With GE trading at $27.20, Carla anticipates the stock reaching $28 by March, with potential downside to $26. Balancing these projections, Carla selects the March $25 call (an ITM strike price) for $2.26.

This $2.26 premium comprises $2.20 of intrinsic value (current price of $27.20 minus the $25 strike price) and $0.06 of time value (total premium of $2.26 minus intrinsic value of $2.20).

Rick, with a more aggressive bullish outlook, seeks higher percentage returns despite elevated risk. Consequently, Rick selects the $28 call for $0.38—an OTM option consisting entirely of time value with no intrinsic value.

Table 2 illustrates how Carla's and Rick's calls would perform across various GE share prices at March expiration. Rick's investment of just $0.38 per contract limits potential losses to that amount, but requires GE to exceed $28.38 (strike price plus premium) at expiration to generate profit.

Carla commits significantly more capital upfront but can recover a portion of her investment even if GE declines to $26 by expiration. While Rick stands to generate substantially higher percentage returns if GE reaches $29, Carla would realize modest profits even if GE climbs marginally to $28 by expiration.

Table 2: Payoffs for Carla's and Rick's Calls

 

 

Note that each options contract typically represents 100 shares, so an option priced at $0.38 requires an investment of $38 per contract, while a $2.26 option costs $226 per contract.

To calculate profit or loss percentages: subtract the strike price from the expiry price, multiply by 100, deduct the total premium paid, then divide by the premium to determine your percentage gain or loss.

For Carla at an expiry price of $26: ($26 - $25) × 100 = $100, then $100 - $226 = -$126, and -$126 ÷ $226 = -55.8% loss.

For Rick at an expiry price of $29: ($29 - $28) × 100 = $100, then $100 - $38 = $62, and $62 ÷ $38 = 163.2% gain. These calculations exclude commission costs.

The break-even price for a call option equals the strike price plus the option premium. GE must reach at least $27.26 at expiration for Carla to break even, while Rick's break-even threshold is higher at $28.38.

Case 2: Buying a Put

Now, Carla and Rick shift to bearish outlooks on GE and consider March put options.

Table 3: GE March Puts

 

 

Carla projects GE declining to $26 by March but wants to preserve some capital if the stock rises instead. She purchases the $29 March put (ITM) for $2.19, comprising $1.80 of intrinsic value (strike price of $29 minus current price of $27.20) and $0.39 of time value.

Rick adopts a more aggressive approach, selecting the $26 put for $0.40—an OTM option consisting entirely of time value without intrinsic value.

Table 4 demonstrates how their respective puts would perform across various GE share prices at March expiration.

Table 4: Payoffs for Carla's and Rick's Puts

 

 

To calculate Carla's profits at a $25 expiry price: ($29 - $25) × 100 = $400, then $400 - $219 = $181, and $181 ÷ $219 = 82.6% gain. Rick's profits would follow the same calculation methodology.

The break-even price for a put option equals the strike price minus the option premium. GE must fall to $26.81 or lower for Carla to break even, while Rick's break-even threshold is lower at $25.60.

Case 3: Writing a Covered Call

Both Carla and Rick hold GE shares and seek to generate premium income by writing March calls.

The strike price considerations differ in this strategy, as the goal is maximizing premium income while minimizing the likelihood of having shares called away. Carla writes $27 calls for a $0.80 premium, while Rick writes $28 calls for a $0.38 premium.

If GE closes at $26.50 at expiration, both strikes would remain OTM, allowing Carla and Rick to retain their full premiums since the stock wouldn't be called away.

However, if GE closes at $27.50 at expiration, Carla's shares would be called away at her $27 strike price. She would earn net premium income of $0.30 (the $0.80 premium received minus the $0.50 difference between market price and strike price). Rick's calls would expire unexercised, allowing him to keep his entire $0.38 premium.

With GE at $28.50 at expiration, Carla's shares would be called away at $27—effectively selling $1.50 below market value. Her notional loss would be $0.70 ($0.80 premium minus $1.50 price difference). Rick's notional loss would be $0.12 ($0.38 premium minus $0.50 price difference).

Consequences of Selecting the Wrong Strike Price

Selecting an inappropriate strike price as a call or put buyer can result in complete premium loss—a risk that increases with farther OTM strikes. For covered call writers, an unsuitable strike may result in having underlying shares called away prematurely. Some investors deliberately write slightly OTM calls, sacrificing immediate premium income for potentially higher returns if shares are called away.

For put writers, an inappropriate strike could force assignment of the underlying stock at prices significantly above current market value—particularly during sharp declines or market-wide selloffs.

Key Strike Price Considerations

The strike price is fundamental to profitable options trading. Consider these critical factors:

Implied Volatility

Implied volatility represents the volatility component embedded in option pricing. Greater price fluctuations correspond to higher implied volatility. Most stocks exhibit varying implied volatility across different strike prices. Experienced traders leverage this volatility skew as a crucial input for their trading decisions.

New options traders should generally avoid writing covered ITM or ATM calls on stocks displaying moderate-to-high implied volatility combined with strong upward momentum, as the probability of assignment increases significantly. Similarly, novice traders should exercise caution when purchasing OTM puts or calls on low-volatility stocks.

Develop a Contingency Plan

Options trading demands more active management than conventional buy-and-hold investing. Prepare contingency plans for your options positions to address unexpected sentiment shifts in specific stocks or broader markets. Time decay rapidly erodes long option values, so consider cutting losses to preserve capital when positions move against you.

Evaluate Multiple Scenarios

Active options traders should develop comprehensive scenario analyses. If you regularly write covered calls, examine potential outcomes whether shares are called away or not. For bullish positions, compare the profitability of short-dated options at lower strikes versus longer-dated options at higher strikes to optimize your approach.

What Is an Option Strike Price?

An option's strike price defines the price at which the underlying asset will be bought or sold upon exercise of the option contract.

What Is the Right Strike Price?

The optimal strike price balances maximum profit potential with minimal risk exposure based on your market outlook and risk tolerance.

Can You Sell Options Before the Strike Price?

You can sell options before expiration, regardless of the underlying asset's price relative to strike. Even with an option whose underlying is approaching your strike from above, you can sell if you find a buyer with a bullish perspective.

The Bottom Line

Strike price selection is perhaps the most crucial decision in options trading, fundamentally impacting position profitability. Thorough research and analysis when selecting optimal strike prices significantly enhance your probability of success in the options market.

The most effective way to test and refine your strategy is through Stocknear's Options Calculator. This powerful tool allows you to visualize maximum profit potential, maximum loss scenarios, and break-even points across different market conditions, providing clear strategic direction for your trades. Options Calculator

Happy Investing!