Selecting Options

Starting Out

Beginners to Options

When you first start out, I would recommend selecting an option that is based on what you are willing to lose completely. If you r max loss (8%) is $100, then select an option that costs $100. While this may be a relatively low delta, if it goes quickly against you it does not risk more than you are willing to lose. If it goes in your favor, you can create stops to close at breakeven or in profit. Here are my tips for beginners.

Select a DTE that is at least 5 days away or longer; this will give your option time to appreciate and not get burned by theta
Consider a DTE that has a theta that is less than delta if possible; otherwise you will need a larger move to overcome theta decay
Determine your risk and select an option based on that amount

Intermediate

Determine your risk for a position
Randomly pick a delta; for instance 30
Attempt to find a DTE where your delta is greater than theta
Calculate the number of options you can own based upon your delta and risk
Set a stop limit based upon your exit

Advanced

Determine your risk for a position
Select a delta close to ITM
Determine whether you are trading intraday or swinging; select a DTE that allows for time to see out your move and that doesn't get crushed by theta burn
At this point in your trading you are very assured of your entries and exits that moves should immediately move in your direction or you will see rejection immediately that you can scale out quickly for a small loss; hopefully less than 8%

Breaking Down Option Selection

The following are case scenarios to help you determine if you should purchase or not. Here are some of the things you should consider when looking at the option price.

What are my targets for the current price action?
Days to Expiration (DTE)
Open Interest and Volume
Delta to Theta Ratio

What my targets for the current price action?

Knowing support and resistance helps to create price targets (though it does not mean it will get there)
Was there a catalyst (news/earnings/interest rates) that is causing the movement?

DTE

How many days to expiration?
Will this be a quick move or will it take time for it to develop?

Open Interest and Volume

Is there at least 500+ Open Interest?
Is Volume spiking on the strikes in the direction I am predicting?
The higher the open interest and volume
- - Higher liquidity, tighter bid/ask, and your ability to get in and out of the market quickly
The lower the open interest and volume
- - Less liquidity, wide bid/ask, difficulty in entering and exiting your position quickly, often lose money in attempting to find a mid range price others are willing to buy/sell

Delta to Theta Ratio

Buying CALLS and PUTS
- Depending on DTE, can my Delta outpace Theta on buying CALLS or PUTS?
- We lose Theta every day until expiration when buying calls
Selling CALLS and PUTS
- Depending on DTE, is Theta relatively high and can I benefit from Selling CALLS or PUTS?
- We gain Theta on each day that passes until expiration

Avoid Earnings

Attempt to close calls or puts prior to earnings
Earnings can have big swings up, down, or sideways
Volatility can often spike prior to earnings and can inflate premiums
Since Options are impacted by price action, theta (time), and vega (volatility) you could select the right direction and be losing money. Be sure to understand the variables to select the right option strategy or simply wait until after earnings.

Using ATR and Time to Determine my Entries/Exits

This depends on your bankroll, time you think it will take to hit your target, and if you intend to hold until you hit your strike or based on momentum
Personally, if I am intraday trading I may select a strike ATM or ITM to take advantage of a quick move and the higher delta
What is the price and ATR of the stock? If you are used to a lower priced stock and a smaller ATR, selecting a higher delta might be best to see any profitability. But, if it is a high priced stock and large ATR, you may want to select a lower strike (lower delta) to get comfortable with the quick movement. I have traded $2000-3000 priced stocks that had ATR's of $70-$90 and when they move, you may see a $2-10 move in a matter of seconds versus a $50 stock that has an ATR of $4 that moves $1-2 dollars in the same time frame.
I personally like to be around the 30-40 delta range in most cases as it provides a decent return in comparison with theta
In my mind, a stock must be able to move (reward) 2-3x theta or I am not interested in that strike and DTE

Should you buy?

DTE = 0; which means it needs to move considerably today
Theta is extremely high due to 0 DTE
We would need to see a significant move and exit before the end of day to see a profit
0 DTE should only be traded by season traders who can get in and out of trades quickly to avoid theta decay and from losing your entire position on a bad move
You can treat 0 DTE as YOLO's, but be careful as you may develop a losing habit

General Statistics on Options

Calls that reach +10% Returns have:

77.2% chance of reaching a 30% return
64% chance of reaching a 50% return
42.8% chance of reaching a 100% return
If it is already up 10%, it's likely to hit 50%

Puts that reach +10% Returns have:

68.5% chance of reaching a 30% return
50.2% chance of reaching a 50% return
27.9% chance of reaching a 100% return
If it is already up 10%, it's likely to hit 30%

General Thoughts (IV Rank/IV Percentile - use barcharts.com) found online

Longer contract expirations take loner to reach substantial profits
For Calls, look for volatility between 69% and 83% for Winners with volume of 400+ and a low Open Interest of 18 to 37
- - Personally, this can be tricky as you will experience slippage in price with a low Open Interest and Volume
  - Premiums of calls goes up when volatility increases and falls when volatility decreases.
  - A higher IV can be a great opportunity to sell covered calls
Volume/OI Ratio >4 but <10 in the first/last 30 minutes of trading day is the most profitable
Best Monthly Call IV is from 81.8% to 124%
Best Monthly PUT IV is from 42.3% to 59.2%
Look for Low Delta and IV under 100%; Be careful with >100% IVs
Best Weekly Call Delta is from (0.178 to 0.321)
Best Weekly Put Delta is from (-0.0834 to 0.178)
Calls have the highest profitability
Most Winners expirations are greater than 1 week and less than 1 month

Theta Crush

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This is an excellent video that helps you to visually see how premiums are impacted by price action. Here are a few tips to help you avoid the same mistake I made:

Buy on pullbacks instead of breaks
Premiums are highest during breakouts as volatility rises (theta decay)
You could purchase prior, but you would have to see a directional move to overcome theta decay

COST Crush

Numbers on Right - Option Price (6.65 = $665)
Purple Line - Theoretical Option Price
Blue Line - Open Interest
Candles represent the price movement of the contract in relationship to the actual price action

Actual Candlesticks and Price Action
On 7/15, I entered into COST calls as it was reaching a new high $524 for 6.65 (Third green candle from the left; prior to high of 6.65)
On the next day it spiked, dropped, and my stop loss was hit
3 trading days later COST was trading at $529 (see chart on left)
However, since I bought a breakout stock that hit a wall and did not continue upwards, volatility retracted and you can see the theoretical option price never attaining the same level of when I purchased.
To give you perspective, despite a $5 rise from the time I purchased, the option price is worth 5.20 or $520.
Some of this is due to theta burn or time decay (about 0.40 or $40 a day) and the rest of it is from the lack of volatility
Should price action rise quickly, volatility would increase and the option would regain some lost value.
This is why we want to find pullbacks, where others panic and sell cheap, that allow us to enter for a better price on others fear or profit taking

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