In this video, we will explore s strategy for selecting option trades. Once you select a stock for an option purchase you then must select an option strike price. Depending on the stock, there could be hundreds or even thousands of strike prices available. How do you determine which strike price to use?
Option Premiums consist of time value and intrinsic value. Each day before option expiration, the Time Value portion of an option decays. Options lose all time value at expiration and consist of only intrinsic value.
So, when you buy an option you are buying a decaying asset. Due to the time decay characteristics of options, when we buy an option, we want to minimize time value and maximize intrinsic value. We use what we call the 1% Rule to select an option strike price that minimizes time value and maximizes intrinsic value.
When you use the 1% Rule to select the strike price, the underlying stock only has to increase 1% for the option to start profiting.
A 1% price movement in the stock to start profiting has a much higher probability of being profitable compared to at-the-money or out-of-the-money strike prices that can require up a 10% to 15% price move in the stock to break even which may not happen before option expiration.
This 1% Strategy will increase your percentage of winning trades compared to trading at-the-money or out-of-the-money options and this higher accuracy can make you a more successful trader.