Stock Options, Picking the Right Strike Price

Options can be a powerful wealth building tool if used properly. But one big mistake you can make when trading stock options is buying the wrong strike price. This can work against you in so many ways. So let’s examine some strike prices and how they can help you.

1. In the Money

An in the money option is an option that already has some intrinsic value. For example stock XYZ is trading at $55 we buy the $50 call for $7. This gives us the right to buy this stock at $50, or $5 below the price of the stock today. This is called an in the money option because it already has some intrinsic value.

This option contract is considered the most conservative approach, you will not make as much when you are right, but they are safer because chances are the option will finish in the money.

2. At The Money

An at the money option is a contract that is at the price of the stock, or closest to the price of the stock. For example stock XYZ is trading at $55 and we buy the $55 call for $4. Now the stock doesn’t have intrinsic value so it is riskier, but it will make a larger gain if the stock does go up.

3. Out Of The Money

Out of the money options are the most speculative instrument on the market. These options give you the potential to make the highest return, but also give you the highest risk. It is an option contract that is far away from the price of the stock.

For example stock XYZ is trading at $55 and we buy the $60 put for $1. If the stock makes a big gain this is potentially the most profitable. But the stock needs to get above $60 before we have any intrinsic value. If the stock moves up to $59 by expiration, our option would expire worthless even though the stock moved up like we assumed it would.

So which one of these options provides the best solution? It depends on the individual trader and how much they want to risk. A conservative trader would choose the in the money option, while a more aggressive trader would choose the out of the money option.

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