Choosing the right strike price when trading options is crucial for aligning your investment strategy with your goals. The strike price determines the premium paid for the option, the intrinsic value, and the profitability of the trade. The following steps will help you choose an options strike price that matches your options trading UAE investment objectives:
Define your objectives:
Start by clearly stating your investment goals. Are you looking to generate income, protect an existing position, speculate on price movements, or hedge against market risks? Depending on your goal, you’ll want to adopt different strategies and choose different strike prices.
For instance, if your goal is to generate income, you might consider writing covered calls or selling put options. In this case, selecting a strike price near the current market price gives you a higher probability of realizing income. However, if your objective is to speculate on price movements, you may choose a strike price farther away from the current market price, allowing for bigger gains if the underlying security meets your predicted direction.
Evaluate implied volatility:
Implied volatility (IV) estimates the market expectation of future price variability. Option sellers benefit from low IV, while option buyers prefer high IV. If you believe implied volatility is going to decrease, you might pick a closer strike price to collect premiums. Conversely, if you think IV will rise, selecting a distant strike price could give you a larger profit potential.
Assess delta values:
Delta is an estimation of how sensitive an option’s price is to changes in the underlying security’s price. Call options have positive delta values, while put options have negative delta values. Buying call options with high delta values means you’re betting on a big rally, while buying puts with high delta values implies a stronger belief in a sharp fall. Ideally, you should match your delta exposure to the degree of conviction you have in your prediction.
Review time decay (Theta):
Time decay affects options differently depending on their expiration dates and strike prices. Options nearing expiration lose value faster than those with longer terms. Moreover, options with strike prices closer to the market price tend to decay faster than those with strike prices farther away. Take note of time decay when picking your strike price, especially if you intend to hold the option till expiration.
Account for transaction costs:
Transaction costs like commissions and slippage can eat into your profitability. Always factor in these costs when deciding on the strike price. Try to find a balance between the desired outcome and reasonable costs.
