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Delta and Strike Price Selection

Strike price selection is the 2nd of our 3-required skills for covered call writing and selling cash-secured puts. I am frequently asked which Delta to use as a guide to a specific strike price. In this article, we will review the factors that guide us to the most appropriate strike price and the role Delta plays in these decisions. In June 2020, Vinh sent me an email regarding a covered call trade being considered with Advanced Micro Devices, Inc. (NASDAQ: AMD) with the stock trading at $50.10 and 19 calendar days remaining until contract expiration. The inquiry was which Delta to use to achieve capital protection?

 

Option-chain provided by Vinh 

 

AMD Option-Chain

 

  • The $46.00 ITM strike has a bid price of $5.10
  • The $47.00 ITM strike has a bid price of $4.40

 

Delta and strike selection

Since one of the Vinh’s stated goals is protection to the downside, in-the-money (ITM) strikes will be favored. In this case, we will review strikes below $50.00. In the BCI methodology, the factor that guides us to the specific ITM strike is our initial time-value return goal range, not a Delta stat. We know that ITM call strikes, by definition, have Deltas between 0.50 and 1.0 but the specific Delta percentile is not the ultimate determining factor. Instead, we turn to our strategy goals. In this case, let’s assume an initial time-value return goal range of 2% – 3% with capital preservation in mind.

 

Strike selection in the BCI methodology

We check the option-chain for ITM strikes that achieve an initial time-value return between 2% to 3%. In this case, we will review the $46.00 and $47.00 strikes.

 

AMD calculations with the multiple tab of the Ellman Calculator

 

AMD Calculations for the July 17, 2020 Contracts

The Ellman Calculator shows that both strikes return the stated  return goal range of 2% to 3% The downside protection of the time-value returns are significant ranging from 6.2% to 8.2%. The lower of the 2 breakeven prices is for the $46.00 strike which is $45.00. Both are excellent choices based on strategy goals. Basing a strike decision solely on Delta stats (.70 and .75 for these strikes) may or may not achieve our system objectives.

 

Discussion

Our strike price selections should be based on strategy goals and personal risk-tolerances. Understanding Delta and its impact on our trades is important but using Delta figures as a sole determining factor for our trades decisions may or may not align with our ultimate objectives.

 

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

32 Responses to “Delta and Strike Price Selection”

  1. Jerry January 23, 2021 3:09 am #

    Alan:

    At what % above the stock price do most calls expire worthless. Recently, I have had one stock or etf that soars way above the strike price, and the “missed gain” exceeds all the combined premiums that I earned for that time period.

    Jerry

    • Alan Ellman January 23, 2021 11:34 am #

      Jerry,

      An option will expire worthless when the option expires out-of-the-money at expiration…(strike price higher than stock price).

      The time-value component of an option will approach zero when stock price moves significantly above the strike price. There will still be a substantial intrinsic-value component to the option premium. The % above the strike if this occurs will depend on the time-to-expiration and the implied volatility of the underlying security. There is no 1 standard % for every security.

      Missed opportunity: When a covered call trade is established, we have an initial time-value return goal with upside potential or downside protection. We are agreeing to sell our shares at the strike price. Now, if and when the strike moves in-the-money, we have maximized our return in return to abiding by our contract obligations. That’s a winning trade.

      Any strategy we use can always be questioned… “had we used a different strategy, I could have made more money” This is an exercise in futility. First, we decide on a strategy, master it and apply it. If we maximize our returns on a trade, we feel good and hope for more of the same moving forward… my philosophy.

      Alan

    • Roni January 23, 2021 5:30 pm #

      Jerry,

      Yesterday afternoon I posted, in response to Tay, about “missed opportunities”. I got a kind answer from Barry B, but I guess it was too late for most members to read it.
      So I decided to post it again:

      “Hello Tay,

      every week someone here is concerned about “leaving money on the table”.
      We, the BCI believers, we cheer when an underlying stock goes up, the more the better.
      We feel that our trade is protected, and will end up assigned, so we will realize our ROI within the 2% and 4% range.
      Please tell me where you can place your cash and get 2% in one single month elsewhere?
      Forget the notion of lost opportunity. You should worry about the losers and manage them to mitigate your losses. The winners are welcome to go to the sky.”

      Roni

      • Hoyt T January 24, 2021 8:59 am #

        Roni,

        Exactly!

        Take care, my friend.

        Hoyt T

      • Marsha January 24, 2021 12:59 pm #

        Roni,

        I agree with Hoyt, excellent post.

        Marsha

        • Roni January 25, 2021 9:20 am #

          Marsha and Hoyt,

          Thank you both.

          Roni

  2. Shirley January 23, 2021 4:04 am #

    Hi Alan,

    Thanks again for the information you make available. Everytime I think I’m not going to be able to master this, I look at your Ask Alan videos and your encouraging manner keeps me going!

    Just doing some position management (all virtual) and would appreciate if you could clarify this:

    AMAT – 01/15/21 expires 02/05/21 (ER 02/11/21) ROO 2.4% DP 3.0%
    ($103.14, Premium $5.50, SP $100.00. Selected ITM because not highlighted)
    Mid-contract unwind calculator – net return on position of 2.10%
    Time value cost to close – -0.17%

    Does this mean I make 0.3% on the original trade (2.4% – 2.10%) but should consider
    unwinding because there is a good chance I’ll find a stock in tomorrow’s Stock Screen that will have a ROO of at least 1% more than -0.17%.

    Just checked the chart and all technicals for AMAT seem positive at this stage.

    Appreciate your help.

    Regards
    Shirley

    • Alan Ellman January 24, 2021 6:46 am #

      Shirley,

      Congratulations, looks like a successful trade so far.

      The spreadsheet shows a time-value cost-to-close of 0.17%. For final calculations, we use our original cost-basis of $103.14, the calculator shows a final realized 9-day return of 2.1%, if closed.

      It makes sense to consider this if we can generate an additional 1.17% or more by 2/5/2021 in a new position with a different underlying. This is the mid-contract unwind exit strategy.

      Keep up the good work.

      Alan

  3. Barry B January 23, 2021 9:25 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 01/22/21.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    On the front page of the Weekly Stock Report, we now display the Top 10 ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.

    Best,

    Barry and The Blue Collar Investor Team

    [email protected]

  4. fabrice January 24, 2021 11:36 pm #

    Dear Allan

    you recently participated to the wealth365 summit. due to time difference, it s difficult for me to see the conference. any replay available ?

    thanks

    Fabrice

    • Alan Ellman January 25, 2021 5:37 am #

      Fabrice,

      I was an invited speaker to present on the Wealth365 platform. The webinars were recorded by Wealth365 but (I have learned) available only to their premium members who pay a monthly fee.

      I will be presenting similar seminars over the next few months, so keep an eye on the event schedule on the BCI site. I will also be placing similar presentations in the Blue Hour Webinar section of the BCI member site.

      Alan.

      • Fabrice January 26, 2021 11:51 pm #

        thanks for your answer Alan

  5. Raj January 27, 2021 2:20 am #

    Alan,

    In your video on selling puts, you mention if the put drops by more than 4% we should get out of the trade.

    I have 2 follow up questions on this strategy:

    1. If the put >4% on the same day as it was bought – should you still get out of it on the same day or do we give it a few days for it come back since its early in the trade?
    2. If the stock is listed in the BCI report as one of the strong picks for the week, should we sell it again at a lower price or move on to another stock?

    Thanks,
    Raj

    • Alan Ellman January 27, 2021 6:39 am #

      Raj,

      My responses:

      1. After having rigorously screened our stocks, if the stock price drops > 3% below the out-of-the-money strike we selected, we buy back that option. It is possible for a share price rebound but it is also possible that price decline will continue. One possible exception is that if the decline was the result of a total market decline in which case we may wait a day or two.

      2. If the stock drops >3% below the OTM strike and the put option is closed, I would look to a different security for my ensuing trade. I would also try to learn from this experience by checking the news on this stock (www.finviz.com is an excellent free resource).

      Alan

  6. Michael January 27, 2021 4:10 am #

    Hello Alan,

    How are you? I’ve bought your Exit Strategies book and have become a member to your members area to understand how best to deal with a position I’m in.

    I’m in a pickle.

    I bought SAVA at $8.49 and have written calls on it with a $10 exercise price, expiring on February 19th. The stock has since risen to $19.43, a more than 100% gain!

    I’m thinking of rolling up and out but have several questions:

    – I’ve read if I roll out I’m foregoing the premium on my first call option (not sure if the premium on my second call option is a gain since I would be writing it to cover the cost of buying back the first)l. The returns confuse me here.
    – I’ve read if underlying stock is in a long term trend, its best to bite the bullet and take the small gain and let the options be exercised. Not sure I understand this either.
    – I was thinking of rolling out to a much later time to ensure the premium on my newly written option covers the cost of buying back the first, but not sure if it’s wise and can I find better monthly returns elsewhere (but stock is up more than 100%)

    I’m wondering if I should just follow a strategy of rolling up and out every month until I am out of the money on the option, but am unsure on how above questions will affect return..

    I do realize if I roll over, I will only do this near or on the expiration date to ensure the time value of the first option is 0.

    Would appreciate any input, as the expiration date is in 3 weeks.

    Regards
    Michael

    • Alan Ellman January 27, 2021 6:49 am #

      Michael,

      This is a best-case scenario. You generated an initial time-value return that meets your goal and are in a great position to also realized all the upside potential as long as share price remains above the $10.00 strike by expiration. This is far from a “pickle”

      Let’s start from this outstanding position we find ourselves in with trades of this nature. Can we make even more money? It is too early to consider rolling-out-and-up. We turn to the mid-contract unwind exit strategy. We check the time-value cost-to-close using the “Unwind Now” tab of the Elite or Elite-Plus Calculators. If we can generate at least 1% more than this TV CTC in a new trade with a different stock, then we close both legs of the SAVA trade. If not, we sit tight, continue to monitor the trade and enjoy the ride.

      Alan

  7. Gaëtan January 27, 2021 10:41 am #

    Hello Alan & everybody!
    I would be happy to have your opinion about the following question:
    According Alan’s method, when monitoring a cash secured put position, there is the guide line that says to BTC when the stock’s quote is at approximately -3% of the strike price of the option you previously sold.
    Now, there is volatility during the trading session and sometimes we can see pretty impressive difference between low and hight intraday.
    I don’t feel confortable to determine when I decide if it is becoming too risky to stay on board.
    Immediately when the stock reaches strike price -3%, near the end of the day, day+1 at the opening?
    Could you help me with that?
    Thank you and good luck in this nervous day on the stock markets!

    • Alan Ellman January 28, 2021 6:49 am #

      Gaetan,

      I refer to this as the 3% “guideline” This gives us flexibility when to close the short put. When this occurs, there has been a significant drop in share price since we use typically out-of-the-money puts. We want to protect our hard-earned money.

      If share price briefly dips below the >3% guideline and then recovers, I would not close. If it shows no imminent sign of recovery, close and move on. Even if share price recovers later, we did the right thing given the information at hand.

      Alan

  8. Alan Ellman January 27, 2021 5:30 pm #

    Premium members:

    This week’s 4-page report of top-performing ETFs and analysis of the top-performing Select Sector SPDRs has been uploaded to your premium site. One and three-month analysis are included in the report. Weekly option and implied volatility stats are also incorporated.

    The mid-week market tone is located on page 1 of the report.
    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  9. Jarvis January 28, 2021 1:02 am #

    Alan,

    I’m looking for some guidance regarding a covered call I wrote for 100 shares of GME stock that I own. Cost of shares = $1960; option sold = JUL 16 ’21 $38 C; premium received = $1250.

    GME stock has risen like crazy and I was looking for a strategy to employ that might help me capture more of the upside above $38 per share. Can you help me or am is it more economic to just accept the shares being called away?

    Jarvis

    • Alan Ellman January 28, 2021 8:02 am #

      Jarvis,

      GME is a crazy story where social media has allowed retail investors to stick it to hedge funds that shorted GME. Pre-market this morning, it’s approaching $500.00 per-share. Yikes!

      I’m a firm believer in corporate fundamentals and those of GME are not what is driving this dramatic share appreciation. The question is when will sanity be restored?

      Now, back to your trade. When we execute a covered call trade our goal is to achieve maximum return when possible. That’s looking pretty darn good right now. In July? We don’t know but right now your 7-month return of 157% is looking safe.

      The mid-contract unwind exit strategy is the first position management technique that would come to mind but the cost-to-close would approach $46,000.00.

      If we decide to take no action, we continue to monitor our trade and enjoy the prospect of that huge 7-month return we hope to realize.

      Alan

  10. Donna January 28, 2021 2:58 am #

    Dear Alan

    How do I apply the 20%/10% rule when the “premium” is a negative amount

    my example is when I rolled the XME up and out from Jan 15 expiry (it was trading at $31.64) @33 strike to February 19 expiry (it was trading at $35.45) 36 strike the cost was $110 per contract

    Should I have rolled it out and up to an in-the-money call instead?

    Thanks
    Donna

    • Alan Ellman January 28, 2021 12:02 pm #

      Donna,

      The 20%/10% guidelines apply to the last option sold. It applies to the option premium received when selling the $36.00 strike. The cost-to-close the original short call is not factored in.

      Alan

  11. Jeff January 28, 2021 11:13 am #

    Hello Alan,

    My question is not related to writing covered calls but a more general question about the “mechanics” of options.
    Say you are the buyer of an option and the stock has risen beyond your strike price as has the option price (bid). Now it´s the expiration day:

    1) Must you sell to close the option or does the system do that for you?

    2) What if you want to actually own that stock?

    When you have time.

    Thanks.
    Jeff

    • Alan Ellman January 29, 2021 7:35 am #

      Jeff,

      If a call option is in-the-money at expiration and no action is taken on the holder of that option, exercise will occur and the option buyer will purchase 100 shares at the strike price per contract. No action is needed if we want to own the stock.

      2. If the option holder does not want to own the shares, the option should be sold prior to 4 PM ET on expiration Friday.

      Alan

  12. Ron January 28, 2021 12:32 pm #

    Hi Alan,

    I was wondering if you have any info on “getting out” of a Poor Man’s Covered Call?
    Everywhere I look, I see how to put on the trade but no one ever talks about what to do when it comes down to assignment.

    Here’s my situation…….

    I have a Poor Mans Covered Call on in AAPL.

    It has been in place for a few months now and I might have to take some action in the next day or two depending on their earnings report. This is my first time in this situation and I’m not quite sure how to handle all the ins and outs.

    I purchased a Jan 21,2022 call with a 75 strike price as my “synthetic” stock position. My cost basis is $4400.

    Currently, I have sold a 148 call against it that expires this Friday. My guess that AAPL will close above $148 with the way things are looking right now.

    With that, I will have to provide someone with 100 shares of AAPL that I don’t have for a cost of $14,800 which I also don’t have. But since I have the long call that is profitable and the stock price continues to go up, I should come out ok……I just don’t know how to get there.

    What is the best way to close out of this position?
    Do I “exercise” my long call and take the shares so they can be taken away?
    When should I do all this?

    As always….Thank You.

    Ron

    • Alan Ellman January 29, 2021 7:43 am #

      Ron,

      It appears unlikely AAPL will close above $148.00 today. If it does and you want to retain the shares, roll the option out or out-and-up (use the rolling tab of the BCI PMCC Calculator).

      If you want to close the entire position, the broker will settle the trade using the long LEAPS as the underlying. I would check with your broker on the specifics on how this is managed before expiration as it may differ from broker-to-broker.

      Alan

      • Ron January 29, 2021 9:44 am #

        Hi Alan,

        Yes, it looks like AAPL has moved the other way and my PMCC will “live to trade another day.”

        Thanks for the input. That is great to know for future situations.

        Rolling out and up would give me more credit, more upside potential and more time…….a win, win, win.

        I know with covered calls, my broker just takes my underlying stock when my call gets assigned. I wasn’t aware they would do the same with the LEAP. I will check with my broker and get those details.

        As always,

        THANK YOU.

        Ron

  13. Bob January 29, 2021 4:37 am #

    Hi Alan,

    I trade a small set of ARK ETFs. If I could use ITM covered calls to provide a bit of downside protection, I would.

    Does your calculator help analyze the proper strike selection?

    Thanks,
    Bob

    • Alan Ellman January 29, 2021 9:07 am #

      Bob,

      Yes. Use the “multiple Tab” of the BCI Calculators which will give us:

      1. Initial time-value return on our options (ROO).

      2. Downside protection for in-the-money strikes

      3. Upside potential for out-of-the-money strikes

      4. Breakeven

      Alan

      • Bob January 29, 2021 9:14 am #

        Hi Alan

        Thanks for responding. Does using ITM strikes suggest that the underlying will be assigned?

        Bob

        • Alan Ellman January 29, 2021 9:16 am #

          Bob,

          Not necessarily. It depends on the position of the strike at expiration. If ITM, we can always buy back the option prior to 4 PM ET on expiration Friday to avoid exercise.

          Alan

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