What Is a Strike Price and How Does It Work?
Master the strike price, a foundational element in options trading that defines the fixed cost for buying or selling an underlying asset.
Options contracts are financial derivatives that provide the holder with the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specific timeframe. These contracts are versatile tools used in financial markets for various strategies, including hedging existing investments, speculating on future price movements, or generating income. A key component of every options contract is the strike price, which defines the terms of the agreement.
Defining the Strike Price
The strike price, also known as the exercise price, is the fixed price at which the underlying asset can be bought or sold if the options contract is exercised. This price is established when the contract is created and remains constant until expiration. It serves as a reference point for the transaction, regardless of the underlying asset’s market price.
Options exchanges typically set strike prices at specific intervals around the current market price of the underlying asset. These intervals vary, typically from $0.50 to $5.00, but can be as small as $1.00 for highly traded stocks. The choice of available strike prices is influenced by factors such as the underlying stock’s nominal value and trading volume. The fixed strike price differs from the fluctuating market price of the underlying asset; their relationship determines an option’s “moneyness.”
Strike Price and Call Options
A call option grants the buyer the right, but not the obligation, to purchase the underlying asset at the specified strike price on or before the expiration date. The relationship between the call option’s strike price and the underlying asset’s current market price determines whether the option is “in-the-money,” “at-the-money,” or “out-of-the-money.” This relationship indicates the option’s intrinsic value.
A call option is considered “in-the-money” (ITM) when the underlying asset’s market price is above the strike price. For instance, if you hold a call option for a stock with a strike price of $50, and the stock is currently trading at $60, the option is ITM. This means you could buy the stock at $50 and sell it in the market for $60, realizing a $10 profit per share before considering the premium paid.
Conversely, a call option is “at-the-money” (ATM) when the underlying asset’s market price is approximately equal to the strike price. If the stock in our example were trading at $50, the call option with a $50 strike price would be ATM. An option is “out-of-the-money” (OTM) when the underlying asset’s market price is below the strike price. For example, if the stock trades at $45, the $50 strike call option would be OTM, as exercising it would mean buying the stock for more than its current market value.
Strike Price and Put Options
A put option provides the buyer with the right, but not the obligation, to sell the underlying asset at the specified strike price on or before the expiration date. Similar to call options, the classification of a put option as “in-the-money,” “at-the-money,” or “out-of-the-money” depends on the comparison between its strike price and the underlying asset’s current market price.
A put option is “in-the-money” (ITM) when the underlying asset’s market price is below the strike price. For instance, if you own a put option for a stock with a strike price of $100, and the stock is currently trading at $90, the option is ITM. This scenario allows you to sell the stock at the higher strike price of $100, even though its market value is only $90, generating a $10 profit per share before accounting for the option’s premium.
An “at-the-money” (ATM) put option occurs when the underlying asset’s market price is approximately equal to the strike price. If the stock in our example were trading at $100, the put option with a $100 strike price would be ATM. A put option is “out-of-the-money” (OTM) when the underlying asset’s market price is above the strike price. If the stock trades at $105, the $100 strike put option would be OTM because selling at $100 would be less favorable than selling at the current market price of $105.