The Strike Price Mistake: Why Being Right in Options Trading Can Still Lose You Money

 

1.0 Introduction: The Paradox of Being Right but Losing Money

It's one of the most common and maddening experiences for new options traders. You do your analysis, you correctly predict that the Nifty will go up, and you place your trade, only to watch it expire worthless. You were right about the market's direction, but you still lost money. How is this possible?

The answer, more often than not, lies in a single, critical decision that traders often overlook: the choice of strike price. This decision is frequently more important than the market analysis itself. It’s the difference between a profitable trade and a frustrating loss, even when your prediction is spot on.

"If you select the right strike price in options trading, you can still make a profit even if your analysis is slightly wrong. But if you select the wrong strike price, you can lose money even if your analysis is perfectly correct."

To understand this principle, you must first grasp how an option gets its price. Every option premium is a combination of two things: Intrinsic Value and Time Value. Intrinsic value is the real, tangible value an option would have if it were exercised immediately. Time value is the speculative "hope" value—the price of the time remaining for the market to potentially move in your favor. This simple formula is the key to everything that follows: Premium = Intrinsic Value + Time Value.

This article will break down the most surprising lessons about choosing a strike price. Using a simple, clear example, we will explore why being right isn't always enough and how to align your strike price with profitable trading principles.

2.0 Takeaway 1: You Can Be Right About the Market and Still Lose Money

This counter-intuitive reality is best understood through the example of an "Out-of-the-Money" (OTM) call option. Let's set up a clear scenario based on a common trading decision.

• Market View: Bullish (you expect the market to rise).
• Current Price (CMP): Nifty is at 20,300.
• Your Target: You believe Nifty will expire precisely at 20,600.
• Your Trade: You buy a 20,600 strike price call option. This is an OTM option because its strike price is higher than the current market price.

Because this OTM option has zero intrinsic value, it seems attractively cheap. Let's assume you pay a hypothetical premium of just ₹20 per share. It feels like a low-cost bet on your analysis.

Now for the shocking outcome. Let's say your analysis was flawless, and the Nifty expires exactly at your target of 20,600. The value of your 20,600 call option is calculated as the expiry price minus the strike price (20,600 - 20,600), which equals zero. The option's value becomes essentially zero (in reality, it expires at ₹0.05, but this is practically worthless).

The net result: your market prediction was perfect, but you still lost the entire ₹20 premium you paid. This demonstrates the immense risk of betting on far OTM options, where even a correct prediction can result in a total loss.

3.0 Takeaway 2: You Can Be Partially Wrong and Still Make a Profit

Now, let's look at the opposite scenario, which highlights the safety and power of choosing "At-the-Money" (ATM) or "In-the-Money" (ITM) options. We'll use the same initial market conditions (Nifty at 20,300, with a target of 20,600), but this time, your analysis is slightly off. The market only rises to 20,500 at expiry, missing your target.

Here is the outcome for an ATM trade:

• You bought an ATM call option with a strike price of 20,300 for a hypothetical premium of ₹50.
• At expiry, the option's value (now pure intrinsic value) is ₹200 (20,500 expiry price - 20,300 strike price).
• Your net profit is ₹150 (₹200 value at expiry - ₹50 initial premium).

Here is the outcome for an ITM trade:

• You bought an ITM call option with a strike price of 20,200 for a higher premium of ₹150. The ITM option's higher premium was not just hope; it was backed by ₹100 of existing intrinsic value (20,300 CMP - 20,200 strike), giving you a powerful head start and a buffer against forecasting errors.
• At expiry, its value (now pure intrinsic value) is ₹300 (20,500 expiry price - 20,200 strike price).
• Your net profit is ₹150 (₹300 value at expiry - ₹150 initial premium).

This reveals a powerful principle of risk management. Even though you missed your price target by 100 points, choosing an ATM or ITM strike price still allowed you to secure a solid profit. These options provided a margin for error that the OTM option did not.

4.0 Takeaway 3: The "Cheap" Option Is Often the Most Expensive Mistake

Why are so many beginners drawn to OTM options? The psychology is simple: the low premium makes them seem like a low-risk, high-reward lottery ticket. It feels like you can control more shares for less money and potentially hit a jackpot.

But it's crucial to understand why these options are so cheap. As we established, an option's premium is made of two components: Intrinsic Value and Time Value. OTM options have zero intrinsic value. Their entire price is composed of time value—the hope that the market will move significantly before expiry. By the time the contract expires, this time value decays completely to zero.

The low price of an OTM option is the market's way of signaling a low probability of success. The cheap premium isn't a bargain; it's a warning sign. You are paying a small amount for a trade that is statistically likely to fail, making it one of the most expensive lessons a new trader can learn.

5.0 Takeaway 4: The Best Strike Price Is Your Safest Bet, Not Your Wildest Guess

Synthesizing these lessons leads to clear, actionable advice. Your goal should be to trade with the probabilities in your favor. For most traders, At-the-Money (ATM) options provide the ideal balance of affordability and a reasonable chance of success. If your strategy prioritizes capital preservation and you want an even wider margin for error, the superior choice is an In-the-Money (ITM) option. Though more expensive upfront, its existing intrinsic value acts as a form of insurance against minor inaccuracies in your forecast.

This logic applies universally, whether your view is bullish (Calls) or bearish (Puts). The key is to understand how "moneyness" works for each. For Puts, the definitions are simply reversed. Since you're betting on the price falling, a strike price above the current market price is In-the-Money, and a strike price below it is Out-of-the-Money. The core principle remains the same: avoid far OTM options, as they carry the highest risk of expiring worthless.

6.0 Conclusion: Trade for Probability, Not Price

Success in options trading is less about perfectly predicting a final price target and more about choosing a strike price that gives you a high probability of success. It's about building a margin of safety into your trades.

Stop gambling on pinpoint price predictions. Start trading based on probabilities. By focusing on ATM and ITM options, you build a crucial margin of safety into your strategy. This approach ensures that you don't have to be perfect to be profitable—you just have to be right about the general direction.

Before your next trade, ask yourself this question: "Are you choosing your trades based on the low cost of a lottery ticket, or the high probability of a sound investment?"