Option Trading Blog

In option trading, there are several basic techniques a trader should be aware of. Suppose you are convinced, with either a Technical Analysis method or whatever method you have under your sleeve, that a certain stock is about to rise in value. What can you do? The Most Bang For The Buck technique will basically tell you which options will rise the highest in value. Of course, it works also with puts if you suspect that there is a stock that will fall sharply in value.

A clarifying note: Highest in value here means percentage wise, and this is what matters at the end. If we buy a portfolio of options that rises 20%, our portfolio will also rise 20%. We don’t usually care how much points the option has risen.

How to do it

The rule of thumb is buying either out-of-the-money options or options with the shortest maturity. We will compute for each option what is known as its elasticity. The elasticity is simply the percentage change in the call price (or put) divided by the percentage change in the stock price. The bigger the value, the more “bang for the buck” it will give us.

As we said, we would expect that out-of-the-money calls and puts would have a bigger bang for the buck. This means for call option, the highest strike prices, and for puts the lowest. Moreover, we would also expect that close to maturity options would also have a high bang for the buck.

Computing it

I have added an excel file you can download here. You can change manually the prices of the stock under the “current price” and the different strike prices under “strike price”. Don’t forget to change also the time to expiry and all the other variables. This would give you the Bang for the buck chart. You don’t have to use my excel file, it is just for you to experiment with it. Just remember the golden rule of thumb I have described before.

Here is a graph of the bang for the buck for both call and put options:

Notice that the bang for the buck rises for calls as the strike price rises, and vice versa for puts