Choosing strike and expiry
Lesson 17 · about 10 min
Every strike and expiry combination is a different trade with a different chance of working. Most losing long-option trades were lost at this step, by picking the cheapest ticket rather than the right one.
The strike decision
XYZ at $50, 45 days to expiration, IV 30%. Three candidate calls:
| Strike | Delta | Price | Breakeven | Move needed to breakeven | Extrinsic | Extrinsic as % of price |
|---|---|---|---|---|---|---|
| 45 (ITM) | 0.80 | 6.00 | 51.00 | +2.0% | 1.00 | 17% |
| 50 (ATM) | 0.53 | 2.40 | 52.40 | +4.8% | 2.40 | 100% |
| 55 (OTM) | 0.25 | 0.70 | 55.70 | +11.4% | 0.70 | 100% |
Now suppose XYZ rises 8% to $54 by expiration:
| Strike | Value at expiry | Cost | P&L per contract | Return |
|---|---|---|---|---|
| 45 | 9.00 | 6.00 | +$300 | +50% |
| 50 | 4.00 | 2.40 | +$160 | +67% |
| 55 | 0.00 | 0.70 | −$70 | −100% |
And if XYZ rises 16% to $58:
| Strike | Value at expiry | Cost | P&L per contract | Return |
|---|---|---|---|---|
| 45 | 13.00 | 6.00 | +$700 | +117% |
| 50 | 8.00 | 2.40 | +$560 | +233% |
| 55 | 3.00 | 0.70 | +$230 | +329% |
And if XYZ finishes flat at $50:
| Strike | Value at expiry | Cost | P&L per contract | Return |
|---|---|---|---|---|
| 45 | 5.00 | 6.00 | −$100 | −17% |
| 50 | 0.00 | 2.40 | −$240 | −100% |
| 55 | 0.00 | 0.70 | −$70 | −100% |
The pattern: the ITM call has the highest dollar profit on a moderate move and the smallest loss when nothing happens, because most of its price is intrinsic and does not decay. The OTM call has the highest percentage return on a huge move and loses everything on anything less. The ATM call sits between.
Rule of thumb for directional buyers: a delta of 0.60 to 0.80 gives you most of the stock's move with a manageable theta bill. Deltas below 0.30 are event bets or lottery tickets, and should be sized as such.
The expiry decision
Same $50 ATM call across expirations, IV 30%:
| Days to expiry | Price | Theta (per day) | Theta as % of price per day | Extrinsic paid per day held |
|---|---|---|---|---|
| 14 | 1.35 | −0.048 | 3.6% | $0.096 |
| 30 | 1.90 | −0.032 | 1.7% | $0.063 |
| 45 | 2.40 | −0.027 | 1.1% | $0.053 |
| 90 | 3.30 | −0.018 | 0.55% | $0.037 |
| 180 | 4.65 | −0.013 | 0.28% | $0.026 |
The last column is the total extrinsic value divided by days, which is the average daily rent. A 14-day option costs almost four times as much per day to hold as a 180-day one. Longer expiries are more expensive up front and cheaper per day; that trade-off is the whole decision.
The double-the-window rule. If you expect a move within N days, buy at least 2N days of expiry. It costs more, but it moves your holding period out of the steep part of the decay curve, and it gives the move room to be late, which it usually is. A trade expecting a move over the next three weeks belongs in a 45- to 60-day option, not a 21-day one.
The event rule. If the trade is about a scheduled event, either buy the expiration just past it and accept the crush (Module 4), or buy well past it so the crush is a fraction of the premium. Never buy the expiration before the event by mistake; check the date on the contract.
Combining the two
A workable default for a directional swing trade with a two- to four-week horizon:
- Expiry: 45 to 75 days out.
- Strike: delta 0.60 to 0.70 (moderately in the money).
- Exit: on a move, or when about 21 days remain, whichever first (lesson 4).
A workable default for a short-term catalyst you are confident about:
- Expiry: the first one past the catalyst plus a week of buffer.
- Strike: at the money or slightly out, delta 0.40 to 0.55.
- Size: smaller, because the loss when wrong is total.
Neither is a recommendation to trade; they are starting points that avoid the two commonest mistakes, which are buying too little time and buying too far out of the money.
Key idea: Choose the strike by delta (0.60 to 0.80 for directional trades) and the expiry at roughly twice your expected holding period. Cheap options are cheap because they usually expire worthless.
The cost-per-delta view
Another way to compare strikes: what does a unit of directional exposure cost?
| Strike | Price | Delta | Price per 0.01 delta |
|---|---|---|---|
| 45 | 6.00 | 0.80 | $0.075 |
| 50 | 2.40 | 0.53 | $0.045 |
| 55 | 0.70 | 0.25 | $0.028 |
By this measure the OTM call is the cheapest exposure, which is precisely the trap: it is cheap per delta because that delta is the most likely to disappear. The ITM call is expensive per delta because the delta is durable. Pay for durability when you want direction; pay for cheapness only when you want a lottery ticket and know it.
Try it: For a stock you follow, build the three-strike comparison table for a 45-day call at flat, +8% and +16%. Then rebuild it for a 21-day expiry. Note how the ATM and OTM results change, and which strike you would actually choose given how far you honestly think the stock moves in three weeks.
Recap
- ITM calls (delta 0.60 to 0.80) give the most reliable dollar profit on moderate moves and lose least when the stock stalls.
- OTM calls give the biggest percentage return on a large move and lose everything on anything less; size them as lottery tickets.
- Longer expiries cost more up front and much less per day; buy at least twice the expected holding window.
- For events, buy past the event with buffer, and know what the crush will cost.
- Cheap per delta is cheap because the delta is fragile; pay for durability when you want direction.
See it drawn
Original diagrams for the ideas on this page. Illustrative, not real market data.