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Hey everyone, Kirk here again at Option Alpha and welcome back to the daily call. Today, I want to talk about choosing strike prices when buying options. Look. If you’re going to go out and you’re going to actually decide to buy options which is not the first thing that we would suggest to do and hopefully, you’ve recognized that by listening to this podcast and checking out our website at optionalpha.com. But if you are going to decide to go out and do some option buying, you have to understand the relationship that’s present between buying options and the price you pay and your probability of success or the amount of money that might make. Now, understand of course that the markets are pretty fair and efficient. If you trade something that’s highly liquid which we suggest you obviously do in any case, then the market is pretty fair and efficient in that you're not going to get a higher chance of winning by paying less money. It’s really what it comes down to. If you think about that as you start choosing different strike prices, you’ll realize that when you pay more money for an option contract, especially when buying options, it basically or effectively means that you're buying options that are further in the money or maybe closer to at the money strikes. For example: If a stock is trading at $100, buying the 105 call option might only cost you $50. It’s $5 out. It might cost you $50. But look, the stock has to move from 100 up and above 105 for you to make money. The likelihood of that happening is pretty low, hence the pricing on that option contract is also low to reflect the probability of you making money. Now, if that same stock was trading at $100 again and you wanted to buy the 100 strike call option, that might cost you $2. Now, you paid $2, so you paid more money for that contract, but now, your breakeven point is 102, so the stock doesn't have to move as far for you to make money on that contract. Now, is this more risky? Well, it's more money out of your pocket, but maybe it has a higher probability of actually generating any return at all. I always talk about at this point, the concept of lottery tickets because I think the concept makes sense in this case which people always go out and buy lottery tickets because they're cheap and they have high payoff potentials. You could buy a lottery ticket for $1 and make millions of dollars. But what’s the probability that you actually get any of that money, that you see a dime in that? Insanely low. The same thing carries weight with options trading. When you buy, in this case, the 105 call option, yes, it’s very, very cheap, it's $50, so it’s a small bet. And so, on a total dollar basis or a notional dollar basis, it's a very low investment, low risk to you, but it has an insanely low probability of actually paying out, so it acts more like a lottery ticket than anything else. As we continue down this path of choosing strike prices, again, as you go in the money, now let’s say that the same stock is trading at $100. Now, instead of buying the 105 or 100 strike call, you buy the 95 strike call, so you’re buying an option that's actually in the money at this point. Now again, you might pay a pretty decent premium for this. You might pay let’s say $6 for this contract. Your breakeven point is still 101. The stock still has to move higher for you to make money. You're not guaranteed a profit at this point. You still probably need some directional movement in the stock, but your higher payment is also locking in a higher probability of potentially making money. Not that you will, but a higher potential to make money. You can see that when choosing strike prices, especially in option buying scenarios, you really want to try to understand the dynamic between how far out you buy options or how deep in the money you buy options and the likelihood of success. And so, I’m okay taking directional bets and we do option buying strategies here and there to hedge the portfolio and reduce risk, balance out other positions. I’m definitely more of the type of trader where I want to buy options around the at the money strikes when I’m doing it. Far out of the money just doesn’t make sense. Far deep in the money is just way too costly. And so, we find a good risk reward in most cases, buying spreads, debit spreads, put debit spreads, call debit spreads right around at the money. So, just to give you guys a quick example of what we might do. If the stock is trading at 100, we might buy let’s say the 98 call option and sell the 102 call option and do a spread. And most of the time, you get a pricing that's right around where the stock is trading. Our breakeven point ends up being effectively where the stock is trading now, so we just need a small movement higher, a small trend higher for us to make money on that type of trade. It’s still a high risk trade because it's a 50/50 bet in most cases which is why we don’t prefer option buying than compared to option selling, but if we’re going to do it, we’re going to do it with at the money strikes or strikes that are around where the stock is currently trading. As always, hopefully you guys enjoy these. If you have any comments or questions on this, let me know. Until next time, happy trading!