Expiration Month And Strike Price For Options by Robert M. Peevey
It never hurts to brush up on the basics, we always say, and so here are the basics of options as well as an analysis of the correct option expiration month and strike price to achieve maximum profit from each trade.
Stock and index options provide a leveraged investment alternative to the direct purchase of the underlying assets. They provide more bang for the buck and place a premium on being correct in predicting price moves — the ideal circumstance for the technician. This article is designed to help technicians in their quest to profit with options by refreshing their memories on how options work, and how to achieve a maximum profit from each options trade.
First of all, an American call option gives its buyer the right but not the obligation to purchase a specified number of units (100 shares for common stocks) of a specific asset (the common stock of Exxon Corp. [XON], for example) at a specified price — the strike price — on or before a specified date — the expiration date, usually the Saturday following the third Friday of the month. For this privilege, the call option buyer pays an amount — the premium — to the seller (or writer) of the option.
The premium consists of two components — intrinsic value and time value. Intrinsic value is the amount that the call option is in the money (that is, the price of the underlying asset minus the strike price of the option). For example, a call option with a strike price of $50 and a current market price of $52 would be $2 in the money, or an intrinsic value of $2. If the call option premium were $3, the time value would be $1. Therefore, the call option premium would be composed of $2 intrinsic value plus $1 time value. One call option for a common stock at a price of $3 represents a $300 investment (plus commissions). Out of the money options have no intrinsic value and the entire premium is time value.