What Is Strike Price in Options? With Examples
Learn what strike price means in options. Understand this fundamental benchmark for contract value, potential profit, and market interaction.
Options contracts provide the right, but not the obligation, to engage in a transaction involving an underlying asset at a predetermined price. Understanding this fixed price is foundational to how options contracts function and how potential outcomes are determined. This predetermined price serves as a benchmark for evaluating an option’s value and profitability as market conditions evolve.
Understanding Strike Price
The strike price, also known as the exercise price, is the fixed 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 created and remains constant throughout its life. It acts as a reference point for assessing an option’s potential profitability relative to the underlying asset’s current market price.
The strike price defines the cost at which the underlying instrument can be transacted if the option is exercised. For instance, if a stock is trading at $50, an option might have a strike price of $45, $50, or $55. This fixed price is distinct from the underlying asset’s market price, which fluctuates with supply and demand. The relationship between the strike price and the current market price influences an option’s intrinsic value and its overall appeal.
Strike Price and Option Types
The strike price operates differently for call and put options. For call options, it is the specific price at which the option holder can purchase the underlying asset. To achieve a profit, the market price of the underlying asset must rise above the strike price.
Conversely, for put options, the strike price represents the price at which the option holder can sell the underlying asset. A put option becomes profitable if the market price of the underlying asset falls below the strike price. The strike price dictates the transaction price for both buying (calls) and selling (puts) the underlying asset.
Strike Price and Moneyness
Moneyness describes the relationship between an option’s strike price and the current market price of its underlying asset. This relationship determines whether an option holds intrinsic value. There are three classifications: in-the-money (ITM), at-the-money (ATM), and out-of-the-money (OTM).
An option is in-the-money (ITM) when exercising it would result in an immediate profit. For a call option, this occurs when the underlying asset’s market price is above the strike price. For example, if a stock trades at $50, a call option with a $45 strike price is ITM. Conversely, a put option is ITM when the underlying asset’s market price is below the strike price. An example would be a stock at $50 with a put option at a $55 strike price. ITM options possess intrinsic value.
An option is at-the-money (ATM) when its strike price is approximately equal to the current market price of the underlying asset. At this point, the option has no intrinsic value. For instance, if a stock is trading at $50, both a call option and a put option with a $50 strike price would be considered ATM.
An option is out-of-the-money (OTM) when exercising it would not be profitable. For a call option, this happens when the underlying asset’s market price is below the strike price. Using the $50 stock example, a call option with a $55 strike price would be OTM. For a put option, it is OTM when the underlying asset’s market price is above the strike price. A put option with a $45 strike on a $50 stock exemplifies an OTM scenario. OTM options have no intrinsic value and will expire worthless if the underlying price does not move favorably.
Practical Examples of Strike Price Application
Consider an investor who believes Stock A, currently trading at $100 per share, will increase in value. They purchase a call option contract on Stock A with a strike price of $105 and an expiration date in three months. Each option contract represents 100 shares. The investor pays a premium of $3 per share, totaling $300 for one contract.
If, at expiration, Stock A rises to $115 per share, the call option is in-the-money. The investor can buy 100 shares at the $105 strike price and sell them at $115. The gross profit per share is $10 ($115 – $105). After subtracting the $3 premium, the net profit per share is $7, leading to a total profit of $700 ($7 x 100 shares). If Stock A only reaches $102 by expiration, the option is out-of-the-money and expires worthless, resulting in the loss of the $300 premium.
Now, consider an investor who anticipates Stock B, currently trading at $50 per share, will decline. They purchase a put option contract on Stock B with a strike price of $45 and a two-month expiration. The premium paid for this put option is $2 per share, amounting to $200 for one contract.
Should Stock B fall to $40 per share by expiration, the put option is in-the-money. The investor can sell 100 shares at the $45 strike price, even though the market price is $40. The gross profit per share is $5 ($45 – $40). After accounting for the $2 premium, the net profit per share is $3, resulting in a total profit of $300 ($3 x 100 shares). If Stock B remains above $45 at expiration, for example, at $48, the option expires out-of-the-money, and the investor loses the $200 premium.