Previously in this column, we discussed why option strikes should be chosen based on their implied volatility. This week, we revisit this argument as a follow-up to a query from an options trader: Why not choose strikes based on time value instead of implied volatility?
Demand factor
Option is a wasting asset, as its value declines with each passing day. This loss in value is captured through the time-value component of the option price. So, the lower the amount you pay for the time value, the better. Time value of an option consists of two factors – time to expiry and implied volatility. You will most likely shortlist strikes of the same expiry when you want to initiate a long call or put position. If the time-to-expiry component is the same for all the strikes, the remaining part of the time-value component must be implied volatility.
So, it appears that choosing an option strike based on time value ought to be the same as choosing one based on implied volatility. To explain, suppose the time to expiry component of an option price is, say, six points. Then, it must be six points for all the strikes with the same expiry. So, whether you isolate implied volatility from time value or not, the choice of strike must remain the same, so the argument goes.
Implied volatility
The issue is that an option’s time value is a function of the location of the strike from the current price of its underlying. That is, higher (lower) a call (put) strike, lower the absolute time value of an option. This is because such strikes are less sensitive to changes in the underlying price as the ones closer to the current underlying price. While the time value of such strike may be lower, their implied volatility could be higher. This is because demand for a strike affects its implied volatility.
You can verify this argument by applying real-time option data into a Black-Scholes-Merton (BSM) model-based option calculator available on the Internet. You need to input the current price of an underlying (say, Nifty Index), strike price, risk-free rate, time to expiry and option price. The output will be each strike’s implied volatility. After you get the initial implied volatility, change the option price by five or 10 points and see how the implied volatility changes. Of course, change in the underlying price will also drive time value. The point is that the change in option price can be greater than the change in the underlying price because of a sharp increase in demand for a particular strike, pushing up implied volatility.
Optional Reading
It is optimal to choose a strike with the lowest implied volatility among the three strikes immediately above (below) an underlying price for calls (puts). This will ensure the option has enough room to capture delta gains after adjusting for loss from time decay (theta). Alternatively, you could choose the immediate OTM strike.
(The author offers training programmes for individuals to manage their personal interests)
Published on August 8, 2026
