What You Will Learn in This Guide
Level: Advanced | Time: about 10 minutes | Cost: free to read online and free to download as a PDF
- Explain CE and PE and split any option premium into intrinsic value and time value
- Understand how time decay works, and how premium decays through expiry day
- Use implied volatility, IV percentile and India VIX to judge whether options are cheap or expensive
- Calculate the expected move and the breakeven before choosing a strike
- Follow a five-step strike selection workflow and a five-point checklist before any trade
What Are CE and PE Options?
CE (Call European) and PE (Put European) are the NSE labels for call and put options. An option's premium is its intrinsic value plus time value. Time value decays, slowly at first and then sharply near expiry, and it depends on implied volatility (IV). Good strike selection means weighing how far the strike is from spot against the market's expected move, not choosing the cheapest option.
This is the advanced companion to the Options Trading for Beginners guide. It assumes you know what calls, puts and the Greeks are, and focuses on how premium behaves and how to choose a strike deliberately. All numbers come from a simplified model: spot 24,000, 15% implied volatility, a 6.5% interest rate, prices per unit.
How Does Time Decay Really Work?
Decay is not a straight line. For an at-the-money option the daily loss is small a month out and grows steadily into expiry, because time value shrinks with the square root of the time left. An out-of-the-money option behaves differently: its daily decay rises more gently, peaks a few days before expiry, then falls away because most of the premium is already gone (in this sample the 24,300 call is worth 333 at 30 days, 93 at 7 days and 5 on the last day).
Visualising It: Premium Lost Per Day, by Strike
The at-the-money call loses about 9 per day at 30 days, and the daily loss keeps growing to 77 on the final day. The out-of-the-money call peaks about 3 days before expiry, then fades as little premium is left. Spot fixed at 24,000, IV 15%. Illustrative model values.
Buyers should read this as a speed limit: the closer to expiry, the faster the option must move in your favour just to break even. Sellers earn this decay, but they are exposed to Gamma, covered next.
How Does Premium Decay Through Expiry Day?
On expiry day, remaining time value is compressed into a few hours. If the underlying stays flat and IV is unchanged, the model below shows an at-the-money option falling from about 77 at 9:15 to 55 at 12:15, 34 at 14:15 and 15 at 15:15, so roughly 70% of its morning value is lost after lunchtime.
Visualising It: Expiry-Day Decay With Spot Flat
The premium falls steadily and then steeply toward the close. The slightly OTM call starts lower and decays to zero sooner. Assumes spot and IV do not change. Real premiums also move with price.
The Theta–Gamma trade-off
Theta is the rent a buyer pays for Gamma, the option's ability to speed up as price moves. For an at-the-money option, the two roughly balance when the underlying moves by its implied daily move:
If the underlying moves less than that in a day, an ATM buyer usually loses money on the day; if it moves more, the buyer usually gains. Sellers have the opposite position. This is a rule of thumb that ignores interest, but it makes IV concrete: you are betting the market will move more, or less, than the option price implies.
How Does Implied Volatility Guide Strike Selection?
IV converts into an expected move, the range the options market implies the underlying may cover by expiry:
= 24,000 × 0.15 × √(7 ÷ 365) ≈ ±499 points
Visualising It: The Expected Move Range
Options are priced as if index levels at expiry follow a bell curve. About 68% of outcomes are expected to fall inside ±1σ. Illustrative model values, not live prices.
Compare any strike's breakeven distance with this range. A call whose breakeven sits half an expected move away needs a moderate rise; one sitting beyond a full expected move needs a move the market already prices as unlikely.
| Call strike | State | Premium | Delta | Breakeven | Breakeven distance (× expected move) | Model chance of finishing ITM |
|---|---|---|---|---|---|---|
| 23,900 | ITM | 270 | 0.61 | 24,170 | 0.34× | 60% |
| 24,000 | ATM | 214 | 0.53 | 24,214 | 0.43× | 52% |
| 24,100 | OTM | 166 | 0.45 | 24,266 | 0.53× | 44% |
| 24,200 | OTM | 126 | 0.37 | 24,326 | 0.65× | 36% |
| 24,300 | OTM | 93 | 0.30 | 24,393 | 0.79× | 29% |
| 24,500 | OTM | 48 | 0.18 | 24,548 | 1.10× | 17% |
Spot 24,000, 7 days to expiry, IV 15% flat, expected move ±499. Model estimates, not live quotes.
The pattern is the point. Moving from ATM to a far OTM strike cuts the premium sharply, but it also pushes the breakeven towards a full expected move and drops the chance of finishing in the money. "Cheap" options are cheap for a reason.
How Do You Choose a Strike?
Match the strike to the objective, then test it against the expected move. These are common conventions for study, not recommendations:
| Objective | Strike zone often used | Reasoning | Main risk |
|---|---|---|---|
| Intraday directional buying | ATM or one strike ITM | High Delta per rupee, tight spreads | Theta and Vega drag if the move stalls |
| Swing directional buying | Slightly ITM, next or later expiry | Lower Theta per day, more time for the view | Higher upfront premium |
| Cheap speculation | OTM within about 0.5 expected move | Lower cost, still a plausible target | Most expire worthless |
| Premium selling with defined risk | OTM near or beyond 1σ, hedged | Higher probability of keeping the premium | A gap through the strike, and a small reward for a large risk |
| Around events | Consider IV first, then strike | IV usually rich before, lower after | IV crush after the event |
IV level: cheap or expensive?
Judge IV against the option's own recent range, using IV percentile or, for Nifty, India VIX. Very low IV makes buying cheaper but does not mean a move is coming. Very high IV makes selling tempting, but IV can stay high or keep rising. Also note skew: puts far below spot usually carry higher IV than calls at the same distance above it.
A Five-Step Strike Selection Workflow
- State the view. Direction, target and timeframe, for example "Nifty to 24,300 within three days".
- Measure the expected move. Spot × IV × √(days ÷ 365) for your holding period.
- Test the breakeven. Strike plus premium (for a call) against your target and the expected move. If breakeven is beyond your target, the trade has no edge.
- Check Delta, Theta and spread. Prefer a strike with a workable Delta, acceptable daily Theta and a tight bid-ask spread.
- Size and exit. Set the maximum loss in rupees, a stop, and a time exit if the move has not arrived.
For reading positioning at each strike, see the option chain guide.
Common CE/PE Mistakes
Choosing strikes by price alone
The cheapest option has the lowest chance. Compare breakeven with the expected move.
Holding a losing option "for a bounce"
Theta grows into expiry. A late recovery must overcome the decay first.
Ignoring IV before events
Buying at peak IV means paying for volatility that often collapses after.
Selling far OTM without a hedge
A win rate of 90% still fails if one loss is many times the size of a win.
Treating expiry day as free money
Gamma makes ATM options swing wildly. Both buyers and sellers can lose quickly.
Ignoring the bid-ask spread
Wide spreads on OTM strikes eat the edge before the trade starts.
Your Strike Selection Checklist
Run this five-point check before buying or selling any CE or PE:
View and timeframe
Do you have a direction, a target and a deadline?
Breakeven versus expected move
Is the breakeven inside the expected move and before your target?
IV level and events
Is IV high or low against its recent range, and is an event about to change it?
Theta and liquidity
Can you afford the daily decay, and is the spread tight?
Maximum loss and exit
Do you know the rupee loss, the stop and the time exit?
Educational content only, and options are high risk. This guide explains option pricing behaviour and is not investment advice or a recommendation to trade any strike or strategy. The values are from a simplified pricing model with flat volatility and are not live quotes. SEBI studies have found that a large majority of individual derivatives traders incur net losses. Never risk money you cannot afford to lose.
Practice Exercises: Apply It on Real Charts and Chains
Reading a concept is not the same as spotting it live. Work through these on the Nifty option chain, and treat the results as practice, not proof. No real orders needed.
Split the premium
Pick one Nifty option from the option chain. Work out its intrinsic value from spot and strike, then subtract it from the premium to find the time value.
Calculate the expected move
Use spot × IV × √(days ÷ 365) for your holding period, with India VIX as the IV for Nifty. Compare the result with the distance to your chosen strike.
Test the breakeven
For one CE and one PE, work out the breakeven (strike plus premium for a call, strike minus premium for a put). Check it against a target you set in advance.
Watch decay on expiry day
Note the premium of one at-the-money option at the open, midday and close on expiry day. Observe only, and write down how the decay speeds up.
About the Author and the Trading Course in Boisar, Dahanu, Palghar & Online
This guide is written by Deepak Kevadia, founder and mentor of Chart Code and BSE NISM certified. Chart Code is a stock market training institute at 208, Yash Padma Arcade, Boisar Tarapur Road, Boisar, Palghar, Maharashtra. Learners from Boisar, Dahanu, Palghar and nearby towns can attend classroom batches in Boisar, and learners anywhere in India can join live online.
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