The strike price, also known as the exercise price, is the fixed price at which the owner of an option either can buy or sell an underlying security.
The strike price is determined at the time the options contract is formed. That strike price is agreed upon between the buyer and seller of the options contract.
Understanding what the strike price is, how it affects the pricing of options and how it determines the ultimate profit from trading an option should be understood.
Generally, the closer the market value of the underlying security to the strike price, the higher the option price will be. In that case, the odds improve that these options will expire “in-the-money.” This means that the market price of the underlying security will trigger the strike price and make the option worth exercising. When the market price of the underlying security does not trigger the strike price by the expiration date, then the option expires worthless and is “out-of-the-money.” Options that are likely to expire “in-the-money” will cost more than options that are likely to expire “out-of-the-money.”
If it is a call option, the strike price is the price at which the holder of the option can buy the underlying security, regardless of the market value of the underlying security. If it is a put option, the strike price is the price at which the holder of the option can sell the underlying security, regardless of the market value of the underlying security.
For call options, the option cannot be exercised until the market value of the underlying security increases to, or above, the strike price. For example, if Walt Disney Co. (DIS) shares were trading at $100 and the strike price of the call option was $102, then the price of DIS stock must rise to, or above, $102 for the option to be exercised. Let’s say that the market value of DIS stock rises to $104. The owner of the call option now has the right to buy the DIS stock at $102 rather than the market price of $104. The call option owner can make a profit of $2 per share, or $200 total.
For put options, the option cannot be exercised until the market value of the underlying security decreases to, or below, the strike price. For example, if DIS shares traded at $100 and the strike price of the put option was $98, then the price of DIS stock must decrease to, or below, $98 for the option to be exercised. Let’s say that the market value of DIS stock declines to $96. The owner of the put option now has the right to sell the DIS stock at $98 rather than the market price of $96. The owner can make a profit from this trade of $2 per share, or $200 total.
Realizing what the strike price is and the role it plays in options is crucial to trade successfully.
