Chapter 11: How to Choose the Right Call Option
Core idea
Buying calls is a bet on three variables at once
When you sold a covered call, time and a flat market were your friends. When you flip sides and become the call buyer, the same forces work against you. To win on a long call, the underlying stock must move in the right direction, by enough magnitude, and before the expiration date. Get any one of the three wrong and the position loses money even when the trade idea was “almost” right.
The chapter’s central guidance is that strike-price selection is the single most controllable lever a buyer pulls. Direction depends on the market; timing depends on the market; but which contract you buy is fully your decision — and that decision encodes the probability you assign to the move.
Moneyness is shorthand for probability
The three terms you must internalize describe the relationship between the stock price and the strike:
- In-the-money (ITM) — for a call, the stock price is above the strike. The option already has tangible value (intrinsic value).
- At-the-money (ATM) — the stock price equals the strike. All premium is time value.
- Out-of-the-money (OTM) — the stock price is below the strike. All premium is time value, and the stock must rally to make the option worth anything at expiration.
The further out of the money you go, the cheaper the contract — and the less likely it is to ever pay off. Cheap options are cheap for a reason.
Why it matters
The most common beginner mistake
Newcomers drift toward the cheapest available strike because the dollar outlay is small and the imagined upside is huge. If a $0.36 call quintuples, that feels like a lottery win. But most far-OTM calls expire worthless. Buying a portfolio of “cheap” lottery tickets is not a strategy — it is a slow leak that occasionally pays back a fraction of cumulative losses.
The author’s rule of thumb: when you are speculating on a moderate move, start with a slightly in-the-money call. You pay more in dollars, but more of what you pay is real value rather than hope.
Intrinsic value is your floor
An in-the-money call has a price floor: as long as the stock stays above the strike, the call is worth at least the difference. That intrinsic value is immune to time decay. Time only erodes the time-value portion of the premium. A slightly-ITM call therefore decays more slowly than an ATM or OTM contract of the same expiration — a structural advantage that is invisible if you only look at the sticker price.
Key takeaways
Key takeaways
- Call buyers must be right on direction, magnitude, and timing — strike selection is the one lever fully under your control.
- In-the-money calls cost more but carry intrinsic value, which acts as a floor and decays more slowly than time value.
- Out-of-the-money calls are cheap because most of them expire worthless; treat them as speculation, not a strategy.
- Premium decomposes into intrinsic value plus time value; only the intrinsic portion is immune to the calendar.
- Breakeven for a long call is strike price plus premium paid — the stock must clear that line before profit begins.
- Don't let sticker price drive the decision; choose the strike whose payoff profile matches your forecast for the stock.
Mental model
Read it as: Every strike is a trade-off between cost and probability. The cheap OTM call is a long-shot ticket; the expensive ITM call gives you a built-in floor of intrinsic value. The author’s default for a beginner buying a directional call is the slightly-ITM strike — the middle path that pays for value rather than hope.
Practical application
- Form a price target first — decide how high you think the stock will go and by when, before you ever open the option chain. The forecast disciplines the strike choice.
- Open the option chain for the underlying ticker and the expiration that lines up with your timeframe. Pull up calls only.
- Calculate the breakeven for each candidate strike: strike + ask premium. The stock must exceed this number for the trade to profit at expiration.
- Default to slightly in the money if you’re new — typically one strike below the current stock price. You pay more upfront but trade less time value for more intrinsic value.
- Resist the cheap-OTM temptation unless you genuinely believe in a large, fast move. Far-OTM calls are lottery tickets, not a sustainable strategy.
- Pick the expiration with enough runway — if your thesis takes 6 weeks to play out, do not buy a 3-week option. Time is the enemy; buy enough of it.
Example
Two traders, same forecast, different strikes
Ravi and Mei both believe Boeing, trading at $88, will rally to roughly $92 over the next month. They use the same expiration but pick different strikes.
- Ravi buys the $95 OTM call for $0.36 — total outlay $36 per contract. For the trade to pay anything at expiration, Boeing must clear $95. His breakeven is $95.36. Even though Ravi’s forecast turns out to be correct, Boeing tops out at $92.10 and his call expires worthless. He loses 100% of his premium.
- Mei buys the slightly-ITM $87.50 call for $2.81 — total outlay $281 per contract. Her breakeven is $90.31. When Boeing hits $92.10, her call is worth about $4.60 ($2.10 intrinsic + remaining time value). She closes for a roughly 60% gain.
Same forecast, same direction, same timing — but only Mei’s strike selection respected the magnitude of the move she was actually predicting. Ravi’s OTM ticket required a bigger move than he ever expected to happen.
Related lessons
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