In today’s post, we’re going to talk about strike prices.
If you’re brand new and you don’t understand what a strike price is when it comes to option trading, it’s an excellent video for beginners.
Also, if you’re more advanced, feel free to skip this video. Go to the other videos that we have, and that are more intermediate and more advanced.
What are Option Strike Prices?
Check out Netflix – here is our ticker symbol NFLX.
There’s probably a lot of different strikes that you’ve seen. There you can see the call side and put side.
Now the question comes down to which strike price do I choose. You have calls, and you have puts, and you have to figure out a strike price.
Each call has a different price. One might have $2.60. This one could be $2.75.
On the put side, there is $3.45 and $5.75.
What you need to do and look at is are you interested in a call or a put.
The second thing is, are you thinking about buying the call or selling the call. Or are you looking at buying the put or selling the put?
Quick note: Remembers there are four different trades that you can do. You could buy a put, or you could sell a put, or you could buy a call or sell a call.
You can do a handful of variations.
When you’re looking at a strike price, you’re looking at these four options that you could do around that strike price.
Here’s a quick example. Let’s say you’re looking to buy or sell a house. If we’re looking at house prices, this is how things work.
I’m looking at a house for 235. Well, 235 what? As a seller or as a buyer?
Because if you’re a buyer of a house, you might want to try to get it for 230. If you’re a seller of a house, you’re probably trying to get it for 245 thousand or whatever the case is.
That’s what you’re looking at. Are you on the buy-side or the sell-side?
In this case, we’re dealing with two different houses in a way. Well, you’re dealing with house call or house put. And that’s what it comes down to.
The thing is if you want to trade around these numbers, here’s how we do it.
Take a Quick Look at Screen
Let’s pull up our Netflix example.
Remember, just like with strike prices; you also have days right here. Here’s the number of days.
Let’s say we go out 65 days; contracts are valid for 65 days if that’s the duration I choose. Well, do I want to be a buyer or a seller? If I want to be a buyer, where do I find value in the calls?
Well, right now, the price is trading at 290. Do I think it’ll reach 300? Yeah, it’s a higher probability, but it’s more expensive. Let’s see what it’s going to cost me.
I’m buying this single, and I analyze the trade. This one, that trade is going to cost me $1570. That’s because the chance of it hitting the 300 is very high in this scenario on the call side.
If I go to 345, it’ll cost me less because the probability is less. But now that stock has to move. I could take a chance on this stock on the call side and say that my strike is way out there at 345 – it’s way further out. But I pay a lot less. I only pay $350.
But it’s got to move a lot more.
That’s the difference. If I get one that’s close, my chance of landing that deal or that house is more likely. If I go far out and say that I’d like to purchase your house if there is gold under your yard, you know the probability and chance is slim.
If you’re going to do some testing and you give them a contract based on that, I’ll take $500 for that. But if there’s a high chance because there’s gold that’s been discovered all over other properties in the neighborhood – we have a different story.
Buddy, you better pay me like $15,000 because the chance of you discovering gold on my property as well underneath the house is very high. That’s because there have been other gold discoveries in the neighborhood.
Being a Buyer and Seller
Ultimately that’s what you’re doing when you’re looking at strike prices. You’re looking at the probability, and it goes the same thing as being a buyer or a seller.
If I sell one of the calls, it’s the same thing. Well, are you going to be able to sell it for more money or sell it for less money? If you sell it for less money, the chance of you as a seller things working out in your favor is really good. You have a much wider range on the call side.
Also, if this is tight on the price because the strike price is tight, the price is 290, and I have to have it stay lower than the 300 – it’s pretty close.
I might make more money, but the chance of it working out in my favor is slimmer. That’s what strike prices allow you to do. It will enable you to budget the risk based on how far or wide you want to get. If you’re trying to do the put side, it works in the same way except now you’re working with a little bit of a different type of contract.
It gives you the ability here for downside movements. If you’re looking at a put, in this case, this one’s already in the money. But let’s say we’re going to a 280 put versus a 240 put.
280 is going to cost me about $1420. If it gets down to $280 per share (right now, it’s at 290), it’s only ten points away. That’s why it’s more expensive. If it goes to 240, it’s far away from that still. And in that case, it only costs you $410.
That’s because the chance of it working out is less, so you pay less for that, but it could still work out.
Ultimately that’s what the strike price allows you to do. It allows you to work and think about where do I want to play this trade. And on the sell-side very similar – what are the probabilities if you’re going to look at that.
Well, if I’m very close, you make more money. That’s because you make about $1300 if it’s very close (ten points away). And if you’re far away, you make less; you only make about $390. But the chance of it working out is very high or much higher than the other way.
Ask yourself: Where do I want to budget or play with this?
If a house is trying to be sold at $500,000 and you try to buy it for $410,000, chances are it’s not going to work out.
But you can still throw in a bid and see what happens. And that’s what you’re doing here with these strike prices and trying to play the field based on the trading that’s going on.
If you have specific trading or investing questions, feel free to submit one by voice here!
Enjoy the week ahead. Thanks for joining me and remember, do what you love, contribute to other people, but most importantly live life abundantly.