What Does Strike Price Mean in Options?
Learn what strike price means in options. Understand this core element that defines an option's contract and future transaction terms.
Options are financial instruments that give the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specific timeframe. They serve various purposes, including speculation and risk management, allowing participants to manage potential price movements of assets like stocks, commodities, or currencies. A fundamental component of any option contract is its strike price, a fixed price established when the contract is created, serving as a benchmark for future transactions.
What is a Strike Price
A strike price is the fixed price at which the underlying asset of an option contract can be bought or sold if the option holder chooses to exercise their right. This price is predetermined and agreed upon by both the buyer and seller when the contract is initiated. It acts as the reference point for the transaction, regardless of the underlying asset’s market price at that future time.
For example, if an option contract for a stock has a strike price of $100, the holder has the right to transact that stock at $100 per share. The significance of the strike price becomes apparent when compared to the underlying asset’s current market price, as this comparison determines the potential profitability of exercising the option.
The strike price is a defining characteristic of an option, distinguishing it from simply owning the underlying asset directly. It provides a clear target price for the potential transaction, offering certainty to the option holder regarding the cost or revenue should they choose to act on their right.
Strike Price and Option Types
The function of the strike price differs depending on whether the option is a call option or a put option. Call options provide the holder with the right to purchase the underlying asset, while put options grant the right to sell it.
For a call option, the strike price represents the specific price at which the holder can buy the underlying asset. For example, if a call option has a strike price of $50, the holder can buy the asset for $50 per share. This right becomes valuable if the market price of the underlying asset rises above $50, allowing the holder to acquire it at a lower cost. If a stock trades at $55 and you hold a call option with a $50 strike price, you can buy the stock for $50 and immediately sell it for $55, realizing a profit.
Conversely, for a put option, the strike price signifies the price at which the holder can sell the underlying asset. If a put option has a strike price of $70, the holder can sell the asset for $70 per share. This right offers protection or profit potential if the market price falls below $70, enabling the holder to sell at a higher price. If a stock trades at $65 and you hold a put option with a $70 strike price, you can buy the stock for $65 and immediately sell it for $70 through the option, securing a profit.
Strike Price and Option Value
The relationship between an option’s strike price and the current market price of its underlying asset directly impacts the option’s intrinsic value and its overall premium. This relationship defines whether an option is considered in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM).
A call option is in-the-money when its strike price is below the current market price of the underlying asset. For example, a call option with a $90 strike price for a stock trading at $95 is ITM because exercising it would allow the holder to buy the stock for $90 and instantly sell it for $95. The intrinsic value of an ITM call option is the difference between the underlying asset’s market price and the strike price. Conversely, a put option is in-the-money when its strike price is above the current market price. A put option with a $90 strike price for a stock trading at $85 is ITM, as the holder could sell the stock for $90 after buying it for $85. The intrinsic value of an ITM put option is the difference between the strike price and the underlying asset’s market price.
An option is at-the-money when its strike price is approximately equal to the current market price of the underlying asset. For both call and put options, being ATM means there is little to no intrinsic value, as exercising the option would not yield an immediate profit. For instance, a call or put option with a $100 strike price on a stock currently trading at $100 is ATM. While ATM options have no intrinsic value, they still hold time value, accounting for the possibility of the underlying asset’s price moving favorably before expiration.
An option is out-of-the-money when it has no intrinsic value and would not be profitable to exercise immediately. A call option is out-of-the-money when its strike price is above the current market price of the underlying asset; a call with a $100 strike price on a stock trading at $95 is OTM. A put option is out-of-the-money when its strike price is below the current market price; a put with a $100 strike price on a stock trading at $105 is OTM. OTM options consist solely of time value, reflecting the potential for the underlying asset’s price to move in a direction that makes the option ITM before it expires.
Availability of Strike Prices
Strike prices are not randomly determined by individual traders or investors. Instead, they are standardized and pre-defined by option exchanges to ensure an orderly and liquid market. When an option contract is created and listed for trading, a set range of available strike prices is established for that particular underlying asset.
These available strike prices are typically offered in specific increments, such as $1, $2.50, $5, or $10, depending on the price of the underlying asset and the liquidity of its options market. For example, for a stock trading around $100, available strike prices might include $95, $100, $105, and $110. This structured list of available strike prices for a given expiration date is often referred to as a “strike chain” or “option chain.”
Traders select from this predefined list of strike prices when they wish to buy or sell an option contract. The existence of these standardized strike prices simplifies the trading process, allowing for easy comparison and execution of trades across various brokers and platforms.