How to Pick the Right Strike
A methodology for selecting the appropriate exercise price
Understanding the Strike Trade-Off
Every strike offers a different balance between cost and probability. ITM strikes, in the money, carry intrinsic value and a higher probability of ending in profit, but they cost more. OTM strikes, out of the money, are cheaper but need a larger price move to be profitable. ATM strikes sit in the middle. There is no universally "correct" strike; the right one depends on your view, your risk tolerance and your available capital. A bullish trader might pick a lower strike, further in the money, if they want a high probability of a gain. That same trader might pick a higher strike, further out of the money, if they want a lower entry cost and greater relative upside. Understanding that balance is what matters most when picking a strike.
Using Probability of Profit
One of the most useful tools for strike selection is understanding the probability of profit (POP). It is generally approximated by the option’s delta. A call with a delta of 0.65 has roughly a 65% probability of finishing ITM at expiration. A call with a delta of 0.30 has roughly a 30% probability. For a call buyer, higher delta means a higher probability of a gain. For a call seller, you want the opposite: a lower delta (a further OTM option) means a higher probability that it expires worthless. Common delta levels for strike selection are 0.25-0.30 for OTM, 0.50 for ATM, and 0.70-0.80 for ITM. Most brokers display the delta of every option, which makes this straightforward. It is worth remembering that delta is only an approximation, based on models that assume a particular future volatility.
ITM or OTM? It Depends on Your View
If you are strongly bullish and believe price will rise significantly, you can pick a lower strike (further ITM) to raise the probability of a gain. That costs more but gives greater certainty of profitability. If you are mildly bullish and do not want to risk much capital, you can pick a higher strike (further OTM) and hope for a modest move. That costs less but needs more movement to make money. For option sellers, the logic inverts. If you expect price to stay relatively stable, you will want to sell OTM options, where they have a high probability of expiring worthless. If you hold a strong contrarian view, you might sell ITM options (though that carries early assignment risk). Spreads let you combine strikes: a bull call spread, for example, buys the lower strike and sells a higher one, balancing cost and risk.
Implied Volatility Considerations
Implied volatility (IV) significantly affects an option’s price at a given strike. When IV is high, every option is expensive, which means OTM strikes can be nearly as costly as ITM ones. When IV is low, there is less price difference between strikes. Some traders make their strike decisions based on IV levels. If IV is very high historically, they may prefer selling options or buying spreads rather than buying outright long options. If IV is very low, they may prefer buying long options. Understanding whether IV is above or below its historical average is useful for strike selection. A very high IV indicates the market expects a large move; a very low one indicates it expects little movement. Your strike selection should align with your view on future volatility.
Breakevens and Required Return
Always calculate the breakeven before choosing a strike. For a call purchase, breakeven is strike + premium paid. If you buy a 100-strike call for 2.50, breakeven is 102.50. Price must rise 2.5% just to reach breakeven. For a put purchase, it is strike − premium paid. Always ask yourself: "is it realistic for the stock to move enough to reach my breakeven in my timeframe?" If the breakeven requires an unrealistic move, the strike is probably not appropriate. Consider your timeframe too. If you only have 30 days, you need a larger move than if you have 90. A strike that is too far OTM for 30 days can be perfect for 90. The combination of breakeven, probability, time and volatility should inform your strike decision.