Identifying Best Strike Price for Maximum Theta decay in a day

A mathematical approach to finding the best strike price for maximum decay in a day

Nov 19, 2024

As I’ve shared before in my article Greeks (Friends & Foes), Theta is my favorite Greek! One day, I asked myself a key question:
Which strike price should I sell to maximize Theta decay while ensuring maximum absolute gain with minimal risk?

Below is a detailed mathematical approach on finding the answer to this question.

Note - To keep things straightforward, this analysis focuses solely on Theta, disregarding other Greeks.

I have attached an excel at the bottom of the article. This will allow a DIY implementation of this.

Key Objective: Maximizing Absolute Returns and Minimizing Risk

Absolute Return Calculation

The goal is to achieve maximum time decay while balancing returns against risks. This is done by analyzing:

Daily Decay (driven by Theta).
Return on Margin (profit as a percentage of margin money used).

Here’s the method I use for rough daily return benchmarks:

Next week expiry: ~0.4% return.
Two weeks ahead: ~0.3% return.
Three weeks ahead or more: ~0.25% return.

Let’s assume some close rough numbers :

Margin required for 25 lots of NIFTY options: ₹50,000
Per-share margin: ₹2,000

To achieve a 0.3% return, we need a daily gain of ₹6 per share. Thus, the option price must decay by ₹6 within the day to meet this target.

Minimising Risk

To reduce risk, the chosen strike price should have the maximum Theta decay as a percentage of the option price. This ensures better returns with less exposure.

The Harmonic Mean Approach

Once we calculate:

Absolute Returns (based on decay and margin).
Risk Reduction (based on Theta decay as a percentage of price).

I use the Harmonic Mean of these two metrics to determine the optimal strike price. The strike price with the highest harmonic mean is the best one to sell.

One important question here is why Harmonic Mean and not any other mean. I chose harmonic mean because of this property of it -

Emphasizes Small Values: The harmonic mean is dominated by the smallest values in a dataset. If any value is very small, the harmonic mean decreases significantly.

You can access the working excel file here -

Open Excel

Results of Analysis

Using the Option Chain for 5th December Expiry, exported at 12:58 PM on 19th November, the analysis identifies 24400CE at ₹52.25 as the optimal strike price to sell.

Given today’s significant market movement upward, selling Call options (CE) seems more reasonable.

Note: This analysis is for educational purposes only and is not a trade recommendation.

How to Perform This Analysis Yourself

Here’s how you can replicate the analysis using data from Sensibull:

Export the Option Chain:

Goto option chain page on sensibull.
Select All Column view from bottom left option.
Use the settings button on the right bottom to open Download Option.
Select Large and Download the excel. Sample Downloaded Excel

Process the Data:

Copy the rows and columns from the downloaded Excel.
Paste them into the Google Sheet provided below.

You can access the working Google Sheet here. It automates the calculations and helps you identify the optimal strike price.

Let’s Collaborate!

If you’ve performed any analysis which talks about answer to the question mentioned on top or spot any mistakes in this, please share your insights. I’m here to learn and grow with you.

Reach out to me on X (Twitter) here.
Drop a comment on this article.

Feedback From Readers

If hedging is done due to reduced margin cost the return can be higher. The loss due to hedge can be offset by the increased position sizing due to reduction in margin requirement. Though complete analysis will have to be done on what can be the further expected gains.

Disclaimer - This is for educational purposes only. Please consult your adviser before taking any trade based on it.