What Is a Strike Price in Options?

Options trading involves financial contracts that provide the holder with the right, but not the obligation, to buy or sell an underlying asset at a predetermined price on or before a specific date. A fundamental concept within options trading is the strike price, which plays a central role in determining an option’s potential value and its eventual outcome.

Understanding the Strike Price

The strike price, often called the exercise price, is the predetermined price at which the owner of an option contract can buy or sell the underlying asset. This price is established when the option contract is initially created and remains constant throughout the option’s life until its expiration date. It serves as a benchmark for the transaction that would occur if the option holder chooses to exercise their right. For example, if an option contract on a stock has a strike price of $100, it means the holder can transact the underlying stock at exactly $100 per share, regardless of the stock’s market price at the time of exercise. The strike price is one of several variables that define an option contract, alongside the underlying asset, expiration date, and type of option (call or put).

Strike Price in Call Options

In the context of a call option, the strike price represents the specific price at which the option holder has the right to purchase the underlying asset. The seller of the call option is obligated to sell the asset at the strike price if the buyer chooses to exercise the option.

For instance, if an investor buys a call option on XYZ stock with a strike price of $50, they gain the right to buy 100 shares of XYZ stock for $50 per share. If, at expiration or exercise, XYZ stock is trading at $55 per share, the option holder can still purchase it for $50 per share by exercising their call option. This allows them to acquire the asset below its current market value.

Conversely, if XYZ stock is trading below $50, for example at $48, exercising the call option to buy at $50 would not be economically sensible, as the investor could buy the shares for less in the open market. The option would likely expire unexercised.

Strike Price in Put Options

For a put option, the strike price signifies the specific price at which the option holder has the right to sell the underlying asset. The seller of the put option is obligated to buy the asset at the strike price if the buyer chooses to exercise the option.

Consider an investor who buys a put option on ABC stock with a strike price of $70. This gives them the right to sell 100 shares of ABC stock for $70 per share. If, at exercise or expiration, ABC stock is trading at $65 per share, the option holder can still sell their shares for $70 per share by exercising their put option. This allows them to sell the asset above its current market value.

However, if ABC stock is trading above $70, for example at $72, exercising the put option to sell at $70 would not be economically advantageous, as the investor could sell the shares for more in the open market. The option would likely expire unexercised.

Strike Price and Moneyness

The relationship between an option’s strike price and the current market price of its underlying asset determines its “moneyness” status. This status indicates whether an option has intrinsic value and is categorized as in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM).

A call option is considered in-the-money (ITM) when its strike price is below the current market price of the underlying asset. For example, if a call option has a $50 strike and the stock trades at $52, it is ITM, as the holder can buy for $50 and immediately sell for $52. Conversely, a put option is ITM when its strike price is above the current market price of the underlying asset; a $70 put on a stock trading at $68 is ITM, as the holder can sell for $70 while the market price is lower.

An option is at-the-money (ATM) when its strike price is equal or very close to the current market price of the underlying asset. For instance, if a call or put option has a $60 strike price and the underlying stock is also trading at $60, it is ATM. These options have no intrinsic value but possess time value, which decreases as the expiration date approaches.

An option is out-of-the-money (OTM) when it has no intrinsic value. For a call option, this occurs when the strike price is above the current market price of the underlying asset; a $40 call on a stock trading at $38 is OTM. For a put option, it is OTM when the strike price is below the current market price; a $90 put on a stock trading at $92 is OTM. OTM options rely solely on the underlying asset’s price moving favorably before expiration to gain value.