What Is Strike Price?

Strike price is the price at which a specific derivative contract can be executed. It is the most important indicator of value for contracts.

The strike price, also known as the exercise price, is usually decided when a contract for an option is first written and agreed.

Some financial products receive value from other financial products. These products are called "derivatives," and there are two major types:

  • Calls give the holder the right, not the obligation, to buy stock in the future at a certain price.
  • Puts give the holder the right, not the obligation, to sell a stock in the future at a certain price.

The price at which calls and puts are bought or sold is called the strike price, which is used to tell call and put contracts apart.

Why Is Strike Price Important

The strike price is important because it is the most useful indicator of option value. It tells the investor what price an asset must reach before it is valuable, or "in the money." By calculating the difference between the current market price of an option and its strike price, an investor can determine whether the option is in the money and how much profit per share would be gained upon its sale.

In-the-money options are activated by default when the contract finishes. If you don't want this to happen, you have to buy-to-close or sell-to-close the option.

Keep in mind that an in-the-money option could activate before the end of a contract if the owner is short. There's no precise way of knowing when this will happen, but as a rule of thumb, the lower the additional value, the higher the risk of this happening.

If the difference between the market price and strike price is unfavorable, the option is worthless and referred to as "out of the money."

If the market price and the strike price are roughly the same, that option is referred to as "at the money."

Premium

The premium is the price a buyer pays the seller for an option. It is an upfront, non-refundable purchase, even if an option has not been executed.

Premiums are quoted on a per-share basis and are priced according to the strike price in relation to underlying stock price (intrinsic value), the length of time until the option expires (time value), and how much the price fluctuates (volatility value). The formula is as folows:

Intrinsic value + Time value + Volatility value = Price of Option

Other factors that set option prices (premiums) include:

  • the quality of the underlying equity
  • the dividend rate of the underlying equity
  • prevailing market conditions
  • supply and demand for options involving the underlying equity
  • prevailing interest rates

Reasons to Consider Using Strike Price

Using the strike price is the best way to tell the status, or moneyness, of an option. This refers to whether the option is in the money (ITM), at the money, or out of the money (OTM) and by how much.

Call options

  • Call options are in the money if the strike price is below the current stock price.
  • Call options are at the money if the strike price is at or near the current stock price.
  • Call options are out of the money if the strike is above the current stock price.

Put options

  • Put options are in the money if the strike price is above the current stock price.
  • Put options are at the money if the strike price is at or near the current stock price.
  • Put options are out of the money if the strike is below the current stock price.

Relationship Between Strike Price and Call Option Price

The higher the strike price, the cheaper a call option will be, allowing investors to purchase stock at a lower price.

The following table lists option premiums typical for near-term call options at various strike prices when the underlying stock is trading at $50:

Strike Price

Moneyness

Call Option Premium

Intrinsic Value

Time Value

35

ITM

$15.50

$15

$0.50

40

ITM

$11.25

$10

$1.25

45

ITM

$7

$5

$2

50

ATM

$4.50

$0

$4.50

55

OTM

$2.50

$0

$2.50

60

OTM

$1.50

$0

$1.50

65

OTM

$0.75

$0

$0.75

Relationship Between Strike Price and Put Option Price

The higher the strike price, the more valuable a put option will be, allowing the investor to get as much money as possible when selling their stock.

The following table lists option premiums typical for near-term put options at various strike prices when the underlying stock is trading at $50:

Strike Price

Moneyness

Put Option Premium

Intrinsic Value

Time Value

35

OTM

$0.75

$0

$0.75

40

OTM

$1.50

$0

$1.50

45

OTM

$2.50

$0

$2.50

50

ATM

$4.50

$0

$4.50

55

ITM

$7

$5

$2

60

ITM

$11.25

$10

$1.25

65

ITM

$15.50

$15

$0.50

Strike Price Intervals

Intervals for strike prices vary depending on the current market price and the asset type of the underlying option.

  • For lower-priced stocks, (those priced $25 or less), strike price intervals are at 2.5 points.
  • For higher-priced stocks, strike price intervals are at 5 points - or even 10 points for very expensive stock of $200 or more.

The strike price interval can also vary depending on whether or not an option is an index option at 5 or 10 points or futures option at 1 or 2 points.

Example of Strike Price

As an example, consider two option contracts. One contract is a call option with an $80 strike price. The other contract is a call option with a $100 strike price.

The current price of the underlying stock is $90. Both call options are the same; the only difference is the strike price.

The first contract is in-the-money and worth $10, because the stock is trading $10 higher than the strike price. The second contract is out-of-the-money by $10.

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