In short:
A strike price is the predetermined set price at which the underlying assets of an options contract can be bought or sold at when exercised. There are two general types of options, calls and puts. For call options, the strike price is the price at which the option owner can buy the security. For puts, the strike price is the price at which the option owner can sell the security.
Key Points
- An options strike price is the price at which the option owner has the right to buy (call) or sell (put) the underlying security.
- The profit from exercising an option will be determined by the difference between the current price of the underlying security and the strike price.
- The strike price is an important part of determining an options value along with time value and volatility.
In-depth:
Understanding Strike Prices
Options are a financial instrument known as a derivative. Derivatives get (or derive) their value from the value of an underlying asset by attaching some claim to the underlying asset. With options, the option value comes from the right but not the obligation to buy or sell the underlying asset at a predetermined price, called the strike price, within a certain period of time.
For example, consider a call option buyer for some stock. The call buyer has the right to buy 100 shares (normal option contract size) of that stock at the strike price even if the shares are now trading higher than the strike price.
Likewise, a put option buyer would have the right but not the obligation to sell 100 shares of that stock at the strike price even if the shares are now trading at a much lower price.
For this reason, the strike price is the most important component of an options contract. The strike price will tell the options trader if the options contract is out of the money, at the money, or in the money and by how much the underlying assets price must change for the contract to become profitable.
Most options are bought slightly out of the money. For call options, this means the current assets price is lower than the strike price. For put options, the current assets price is above the strike price. Out of the money options contracts have no intrinsic value, or in other words, all of the options value is a result of the time to expiration and the likelihood that the contract will exceed the strike price by expiration.
Once the underlying assets price exceeds the strike price the option becomes in the money. In the money options have intrinsic value, meaning some of their value comes from the difference between the assets price and the strike price. In the money options are exercised to realize the price difference between the strike and the underlying asset.
Strike Price Example
To get a better grasp of how strike prices work we can take a look at both a call option and a put option:
Call example, say we were interested in buying a call option on Google, technically Alphabet, (GOOGL) with a strike price of $2,760 and an expiration date 2 days away. If the current price for GOOGL is $2,751.30 this means our call option is out of the money and will need to gain more than $8.70 in 2 days to be in the money.
Fast-forward 2 days and say GOOGL stock rose $10.70 to $2,762 which is above our strike price. This means our call option expired in the money and would be executed but did this call option make money?
To answer this, we would need to know what the premium was. Say the premium was quoted as $13.80/share. We need to multiply this by 100 shares the standard options contract size meaning our call option premium was $1,380.
With this information we can now see if we made money as follows:
( Current price – Strike price ) * # Underlying assets – Option premium = Profit/Loss
($2,762 – $2,760) *100 – $1,380 = -$1,180
In this case, no, we lost money with this call option even though the underlying asset surpassed the strike price.
Put example, say you were interested in buying American Express (AXP) 170.00 October 8 2021 puts. This would mean the strike price is $170. The current premium is quoted at $1.29 meaning the total premium for 1 standard contract is $129. Additionally, the current price for AXP is $173.94 with 5 days remaining until expiration.
Does buying this put option make money?
Fast-forward to expiration, AXP is now trading at $176.32 meaning the option is out of the money. It would not be wise to exercise the option.
Thankfully the maximum amount you could lose is $129, the price of the premium.
What would the math look like if you did exercise the option?
( Strike price – Current price ) * # Underlying assets – Option premium = Profit/Loss
( $170.00 – $176.32 ) *100 – $129 = -$761
Frequently Asked Questions
What happens when a call hits its strike price? When a call option hits its strike price it becomes in the money meaning it can be exercised by the holder for a gain. Just because a call option is above its strike price does not mean a profit will be made.
Spot price is the current market price for a physical asset whereas strike price is the agreed-upon price of an option contract.
Strike prices are set around the current trading price of underlying assets in standardized fixed dollar amounts. Options at different strike prices may be quoted but are only formed at that strike when and if an option buyer can be matched to an option seller.