Copyright Power Financial Group 1 Picking the Magic Strike Price Ernie Zerenner President Power Financial Group, Inc. PowerOptions.

Copyright Power Financial Group http://www.poweropt.com/oxp2/

1

Picking the Magic Strike Price

Ernie Zerenner

President

Power Financial Group, Inc.

PowerOptions – www.poweropt.com


2

Introduction

Option investing has several degrees of freedom more than equity investing: Strike price Time decay Month selection

This talk will concentrate on the choice of the strike price for both buying and selling strategies.


3

Basic Covered Call Calculations

Using the option premium for each

strike price, our option chain calculates: % Downside Protection % if Unchanged % if Assigned % Probability the Stock Price will be above

the Strike Price

4Copyright Power Financial Group http://www.poweropt.com/oxp2/


5

Observations on Option Chain

Observe the general trend in pricing as the strike price increases: Option premium declines % Downside protection declines % if Unchanged is highest ATM % If Assigned increases % Probability Above declines

6Copyright Power Financial Group http://www.poweropt.com/oxp2/

XYZ ($81) with 44 days left

Strike

Price

Option

Prem.

%DnSd

Protect.

% if

Unchg.

% if

Assign.

% Prob.

Above

75

ITM

$6.70 8% 1% 1% 90%

80

ATM/ITM

$2.75 3% 2% 2% 60%

85

OTM

$0.65 1% 1% 6% 18%


7

How to interpret the data

High returns comes with a “risk” Highest return (if unchg) is ATM Greatest safety is ITM Greatest potential gain is OTM The more the potential gain then the

lower the possibility of success based on probability


8

Back to the point in Question: What strike?

It all depends on your own risk reward profile: Looking at the last 2 columns of % if Assigned

and % Prob. Above as a pair The lowest return of 1% has a 90% chance of

happening (highest % Probability Above) The highest return of 6% has only an 18% chance

of happening (lowest % Probability Above)


9

What Strike based on Risk

Looking at the % Downside Protection and the % If Assigned columns as a pair: The highest downside protection has the lowest

return, but the stock price can fall and still win The highest return is possible at the highest strike

price, but it has the lowest downside protection To achieve the highest returns requires the stock

to rise in price. If it does not rise the return is lowest of all.

The highest strike price is a play on stock appreciation not covered call income


10

Real Life Example

Retired and looking for income

Preservation of capital is more important than speculative gains

Want a better return than a CD or a Bond

Want to reduce the volatility of my holdings


11

Some of My choices

Case 1 – Already own stock and want to earn income.

Case 2 – Have cash and want to do a buy / write to generate income


12

Case 1 – Already own

Use strikes ATM or slightly OTM Want to avoid being assigned therefore

must roll up and out if ITM. Must watch dividend exposure to avoid

early assignment. Actively manage by buying back the

option if it declines and rolling down


13

Case 2 – Buy / Write Always go ITM Sacrifice large returns for safety As a rule of thumb limit annual gains to 20 to

30% Max. Reduce the excess gain by going further ITM. Actively manage the position by liquidating

once 70 to 80% achieved.


14

Summary on CC Strikes

It’s all about risk / reward

Each situation is different, but each strike has a set of characteristics, which can be tailored to your circumstances

Be sure you have the tools and calculations available to make the smart choices


15

That was selling options

Now we discuss buying options Investors tend to pick the wrong strike price!

Choices based on number of contracts? Go deep OTM for cheap options Go ITM for high delta and low time premium


16

Picking a Strike when Buying

We need to decide: Which month & strike. How much time premium should we buy The more ITM the more it costs More time costs more money This all effects the number of buy contracts But, where is the best return?


17

Tool to Maximize Returns

Assumptions in developing the tool Forecast the stock price Time frame for the move How much will you invest Will volatility change

Based on these inputs the best return can be calculated for every possible strike price


18

Input Example:


19

Output Example:


20

Summary of Buying

Make a forecast for the stock Determine the time the move will take How much you want to invest Then use a tool to calculate the best strike

to use based on returns.


21

http://www.poweropt.com/oxp2/

Use the above URL for a 30 day FREE Trial Toll free help using the site Try these techniques by paper trading One-click trading for optionsXpress clients 877-992-7971 (toll-free)


22

Tomorrow’s presentation

Tools and Software

How to Find Option Trades with SmartSearchXL

4PM Friday May 5th

Copyright Power Financial Group 1 Picking the Magic Strike Price Ernie Zerenner President Power Financial Group, Inc. PowerOptions.

Documents

highest strike price

possible strike price

strike price option

probability slide

income slide

strike price increases

wrong strike price

month strike