 Hey everybody, Lee Lowell here from SmartOptionSell.com. Welcome to another edition of our YouTube option educational videos. Today is Saturday, July 24th, 2021. What we are going to be talking about today as you can see on your screen, the key to picking the best option strike. I get lots of questions from new option traders. They ask me, Lee, I wanna trade options but I still don't understand which option strike is the best. There's so many different strikes to choose from different expiration dates. Can you please help me understand how to choose the best one? So today, what we will be talking about is we're only going to be discussing the buying side of options today and we're going to discuss buying call options. So on the bullish side, you know, here at the SmartOptionSeller, we're typically option sellers and mainly we sell put options but that's another story for another day. So today we are going to talk about what's the best strike to buy when you're bullish on a stock and you wanna choose a call option, okay? So obviously when you're bullish on a stock and you don't wanna buy the stock you wanna try your hand at buying call options, you have to choose a strike price obviously and you have to choose an expiration date but there's multitudes of strike prices and there's multitudes of expiration dates. So how do you choose? What's the best one to choose? That's what we're going to look at today. Now first and foremost, going by the list here, you have to understand what your break even level will be if you purchase a call option, okay? You're bullish, so you think the stock's going to go up. Now obviously you don't know how high or how far the stock is going to go and you don't know when it will get there but the first key factor is you have to know what the break even level is. If you buy a stock, the break even level and the cost basis is whatever the stock costs at that time if the stock's at 100 and you buy it at 100 that's your break even and that's your cost basis. And every option contract has a break even level as well or a cost basis. How do you figure that out? Well, you have to take the strike price and add it to the cost of that option and that will give you the break even, okay? And you always have to compare that break even to where the stock's break even level is. So if the stock's at 100 and you buy a call option where is that call options break even in conjunction to the current price of the stock, okay? Stocks at 100 is your option break even at $101 a share or $120 a share, okay? That will determine how far the stock needs to go in order for you to at least break even if you hold it until expiration. Now there's a question of should you always hold until expiration or should you get out of the trade ahead of time and I'll show you a couple examples of why it's important to possibly make the trade or end the trade before expiration, okay? So the first two things here are critical. You must know the options break even and you have to compare it to the stock's break even because that'll tell you how good of a chance you have of the stock moving to your own break even when you buy that call option. Now the further the break even level, the harder it is to make long-term profits. So if the stock's at 100 and you need the stock to go up to 120, that's a good distance. I mean, you have no idea if the stock's going to get there within the timeframe and continually trying to make a stock or pick an option where stock has to move a good amount is harder to make profits in the long run, okay? And number four here, will you hold until the expiration date? Now most option traders will hold all the way until the expiration date because they want to get the most out of the option, right? If you have, if you bought a six-month option, most likely you're going to hold for six months because you don't want to miss out in any opportunities for the stock to really move in your favor. But sometimes that's not always the best thing to do. Sometimes it's better to get out of the trade before the expiration and I will show you why that is, we'll look at an option example. Now, if you don't understand that, just think about it in this way. Let's say you go to Disney and you buy a five-day park hopper pass, right? You have five days to go through all the parks at any time you want, but you decide to leave after one day. You've paid for five days, but you leave after one day. And to most people, that would just seem silly because you're just throwing money away. You have four other days that you didn't use. Well, for some people, that's why they hold on till options until the expiration date because they want to use as much time as possible to get as much bang for their buck. But like I said, sometimes that's not always the best way to handle it in the options market and I'll show you why, okay? So the key to picking, one of the keys to picking the best option strike is figuring out where the breakeven level is. And so you'll know how far the option has to move in order for you to at least breakeven. That's the goal, to at least breakeven, right? You don't want to lose, obviously you want to make money, but you have to know the breakeven. So let's, we're going to look through an example and see how that works with AMD stock, okay? And let's just pull up the chart real quick and I'll show you AMD and we'll come back to this page. So here's my chart AMD. Now AMD closed yesterday, Friday, July 23rd at $92.15, see right here, okay? So for someone who might be bullish, now this is just an example, this is not a real recommendation. Someone who might be bullish on AMD thinks the stock is going to move above $100 a share. Here's your all-time high for AMD, just under 100. So if you're bullish, think it's got a nice little uptrend here, you're thinking it's going to take out its all-time highs here and move above 100. So you're bullish on the stock, you don't want to buy shares of stock, you want to buy call options instead because you know call options will cost less dollars than buying 100 shares of stock. And we always compare it to buying 100 shares of stock. Okay, so let's move this back down a little and let's go back to our sheet here. So here's what we're going to do, we're going to compare buying different strike prices on AMD because we're bullish on the stock, okay? So the stock's at $92.15 and obviously that's the stock's break-even. You buy it at $92.15, that's your cost basis. Anything above that, you're making money, anything below that, you're losing money. So now we're have a task of trying to figure, okay, I'm bullish on AMD, what is the best call option strike to buy? Now I'm going to show you an example of buying an in-the-money option versus an at-the-money option. What's the difference between the two? An in-the-money option on a call option strike price. So let's just say AMD's at $92.15 and in-the-money call option strike price is set well below the price of the stock. And at-the-money call option strike price is roughly the same price as the stock. Okay, so we're going to look at a couple different examples. And in this trade, this hypothetical trade, we're going to look at a $67.5 call. See the stocks at $92.15, $67.5 call is set well below the current price of the stock. The at-the-money call option we're going to look at is the $92.5 strike, which is very close to the current price of the stock. Okay, and let me just pull up my interactive brokers option chain here. So this is interactive brokers. We've got call options on the left, put options on the right. I'll move myself over here. So we're going to look at two different options I just said, an in-the-money and an at-the-money. And we're going to look at December, 2021 options, 146 days in the future. Now, this is just a random month that I picked. You can choose any month that you want, but we're going to give ourselves some time. We want AMD stock a chance to move higher. So you have to give yourself a little time because in case you're wrong, AMD goes down first and then it takes a little while to go back up. But you're bullish, so you want to give yourself some time. We're just randomly looking at December. So the 67.5 strike is in the money. And when I teach people which options to buy in the money, we always look for at least a 90% delta. Now, we look at the delta column. It tells us the numbers. Delta's range from zero to 100 or 0% to 100%. And we want to choose a delta with at least a 90% value. So the 67.5 strike has a 90.8% delta. That's the one we choose as our in the money choice. And that here went out yesterday, $25.15 bid at $26.50 offer. So a little wide. So we always try to do something in the middle, but in this case, we're going to say we can get filled for $26 per contract. These are quoted in dollars per contract. And you have to multiply that by 100 to get your actual costs. So if we buy this thing for $26 per contract, it's actually $2,600 that it will cost us, okay? So we're going to look at this one. And we're going to look at an at the money call, which would be the 92.50 strike. And that's roughly the same price where the stock is. And intuitively, you would think, well, that is close to a 50% delta. It's got a 54.3% delta. Went out yesterday, 8.75 bid at 8.95 offer. So we'll buy something right in the middle at $8.85 a contract, okay? So we're looking at $26, $2,600 cost versus an $885 cost. So right off the bat, you're going to see an in the money option cost more dollar wise, all right? But is that a bad thing? Well, we're going to take a look at the example here. Move myself back here. Now we scroll down. Now remember stocks at 92.15, the in the money 67.50 call we buy for $26 a cost, okay? What is the break even? Remember, very important. What is the break even of this call option? Well, in order to find the break even, you take the strike price, 67.5, and you add it to the cost of the option. And that comes out to $93.50. So if you bought that call option and you held it all the way to expiration, your break even would be a stock price and AMD stock price of $93.50. That's only $1.35 higher than AMD's current price of 92.15. So do you think that AMD can go from 92.15 up to 93.50 in your, you know, four and a half months? It's pretty probable, right? AMD's been going up, it can go up. We go back, look at the chart. I mean, all AMD has to go up is a little over $1 to reach break even if you bought that call option, that in the money call option, okay? Now let's go back and look at the, at the money 92.5 call. What's the break even? Well, it costs $8.85, you add that to the strike price. Your break even is $101.35. And that's $9.20 higher than where AMD is now. So if you bought the at the money call option, it has to go up at least $9.20 higher than where it is now if you hold until expiration in order to just break even. That's not making any money, that's just breaking even, okay? So you see the difference here, the in the money call only has to move $1.35 higher, whereas the at the money call has to move $9.20 higher at expiration, okay? Keep saying that because I'm gonna show you what happens if you don't hold until expiration and you'll see how the difference in the profit levels are. Now, what happens if AMD ends up at $101.35 at expiration? And why did I choose that? Well, that's the break even price for the at the money call. So at expiration, if AMD is at $101.35, here's how the profits break down. The in the money call will have an overall $7.85 profit, $785, and how do you figure out, how do you figure out what the P&L is? Well, what you have to do is you take the price of the stock at expiration, you subtract out the strike price, and then you subtract out the cost of the option, okay? All of that, this equation right here, comes to $7.85 profit. It's a 30% return on investment. Remember, return on investment is your profit divided by your initial cost. So you take the 7.85 profit divided by your 26 cost and you get your 30% return on investment. The at the money call at expiration with the stock at $101.35, you will have zero profit. You bought that call, you have zero profit. How do you figure? You take the current price of the stock at expiration, subtract out the strike price, subtract out your cost of the option, it equals zero dollars, zero ROI. Now, AMD moved up from $92.15 up to 101.35. The stock moved up, it moved up like you thought it would, right? It went up, but you didn't make any profit if you bought that at the money call. So you were right, the stock went up, but unfortunately you didn't capitalize on it. You made zero dollars, which is very frustrating because you were right on all aspects but you just didn't buy the right strike price. At expiration, you got zero dollars. Now, if you bought the in the money call, you made a profit. Stock went up and your call option went up. Now, the stock itself had $9.20 profit. It's a 10% return on investment. So if you bought the stock, you got 10% return on investment. If you buy the in the money call, you got almost the same amount. Here's 9.20 profit for the stock, 7.85 profit for the option, but look at the difference in the return on investments, 30% here, 10% here. So you're doing better with the in the money call option. Right? So there's a difference right there. I'm a proponent of buying in the money options because it allows you to make the money when the stock moves up and you don't have to worry so much about the stock really needing to go up far in order to profit. The at the money call, yes, it costs less, but you have the stock has to move a lot more in your favor in order to be correct. Now, in this case, the stock did move in your favor if you bought the at the money call, but it didn't move far enough. All right? Now, let's go over why it's not always the best thing to hold all the way until expiration. Okay? Here's my lovely wife behind me. You can see her moving around. So let's take a look at an option calculator at ivolatility.com. So let's take a quick look. Here's my website. Let's find the ivolatility website right here. And we're gonna look at the AMD and figure out what you can do to offset that case where the stock moves in your favor and you don't make any money. And that is by selling that option prior to expiration. So let's take a look. Let's go to AMD here. Type it in. Now, this is ivolatility.com. This is their option calculator. I use it. I tell my students to use it very easy. Now, what we're doing is you can see here yesterday on Friday, July 23rd, AMD closed at $90.15. Okay, that's what we've been talking about. And we're looking at the, let's go out to December. And we're looking at the $92.50. You can change any parameter here. The $92.50 call options, calculate. So you can see that call is worth $8.74 a contract. In our example, we used $8.85 a contract. So we're about a dime off here. But for example purposes, it's all the same. So let's take a look at what happens if AMD goes up to, what was our break-even price here? Break-even was $101.35 for the at-the-money call. So let's take a look at what happens. We're going to move up the price to $101.35. $101.35. And let's just say two weeks later, let's just say that AMD went up to $101.35 in two-week time span. And we'll have to drop the days expiration down to 132 days. So that's two weeks will pass. Now remember, watch this, $8.74. When I click on calculate, this is going to change, okay? Now I raised the price of the stock, kept the strike price the same. I just moved the expiration time ahead 14 days. And we'll hit calculate. So now you'll see that option is worth $14.11 per contract. Okay, so AMD made that nice big jump quickly. You have a nice profit built up. You've made over $6 a contract, over $600 a contract. And just two weeks time, that's a nice profit you can lock in right there. But let's see what happens if we take this down to one day left before expiration. Let's say you decided to hold all the way to expiration and there's only one day left. Watch what happens to the call option value. It's still at $101.35, but there's only one day left to expiration. What happens? The option value falls all the way back down to $8.85. So basically the option is worth exactly what you paid for on day one. So you waited all that time, all those months. The stock went up and now you're left with your breaking even. You can sell that option at $8.85 a contract and you'll make no money. But had you sold it earlier after the first two weeks, you could have captured over $600 a profit. So my advice here or my opinion is that if the stock moves up in your favor quickly, if you're buying those at the money options, think about locking in some of those gains. Lock in some of those gains because what might happen is as time moves towards expiration, you're gonna give up all that extra time value. What's time value? Time value is just that portion of an option's price that gives it extra value because there's still lots of time left until expiration. More time equals more money. So the more longer out in expiration, you're going to pay for that extra time. But as the option moves closer to expiration, that time value gets stripped away from the price of the option. So that's what happened. It went from $14 a contract down to $8.85 a contract just because of the passage of time. Now had you waited, now you're only just going to break even. So my thoughts are that if you have a profit built up that quickly, take some money off the table because if you wait all the way until expiration and the stock doesn't move anymore, then you're going to lose money. Now let's see what happens. Let's just say AMD closed at $99 a contract. $99 per share on expiration. And so now it's worth $6.50. So now you're actually lost money. You paid $8.85 for it. It's worth $6.50. You've lost money on the option even while the stock has gone up in price. That's a hard thing to handle because the stock moved into your favor. It went up like you thought it would but you still lost money on the option by buying that at the money option. Now the in the money option is always going to move up in accordance to where the stock moves. So you'll always have that. You're going to get a lot more bang. I should say the in the money option is going to move right along with the stock. So you'll gain that same amount of value. AMD only had to move $1.35 per contract per share with those in the money options. So those will gain value as the stock moves up. And there's not a lot of time value that you're going to lose within the money options. That's critical. In the money options, don't lose a lot of value to that time value where like the at the money options do, okay? So it's very critical to understand that. Let's go back to our sheet here. So if you're buying at the money options, you must be very sure that the stock will move past the break-even by the expiration date if you hold it until expiration. So that's what I'm trying to tell you. If you're holding till expiration, stock really has to go well past your expiration to make money. So think about selling some before expiration if you have a decent profit locked in. How much profit is a decent profit? That's up to you to decide. 50% profit, 25% profit, whatever. Don't let your option give away all that profit built up. Take money off the table. Yes, it's enticing to hold it all the way to expiration because you wanna see how far the stock could go. But sometimes in the options world, you have to take money off the table, okay? And buying the in the money options had that built in value right from the start, okay? So there's your lesson today on which strike price could be the best strike price for you. You have to figure out where you think the stock's going to go, but know the break-evens. That's very important. And think about are you going to hold until expiration date, okay? So that's it for the little lesson here today. I hope it's been helpful. Let's take a look at our website real quick. Smart Option Seller. Obviously we're talking about buying options today, but the option seller, smart option seller, we sell options, we sell put options, the put option credit spreads. So if you're interested in that, get our free Put Selling Basics Guide. Go to our website smartoptionseller.com, click on the Put Selling Basics Guide tab here and to your name and email address down here. We'll send you a free copy. And if you need to know what we do, we run some newsletters. We have our Smart Option Seller newsletter. We have our vertical spread trader newsletters all about selling put options and put option spreads. And we have our one-on-one coaching service to help you get over that hump to becoming a better trader. All right, well that's it for me today. I hope it's been helpful. Don't forget to subscribe to this channel. Hit that red subscribe button in the bottom right corner of this YouTube video. Leave me a comment, give me a thumbs up and send me an email. I'll always answer and that's it. I hope it's been helpful. I hope everyone has a great weekend and a great week ahead. I'll see you back here next weekend. This is Lilo signing off.