The strike of an option is the price stated in an option contract at which the option holder has the choice to acquire or sell an underlying asset at a fixed rate during or after a defined time-lapse. For a call option, the strike price is the price at which the contract holder has the option to buy an underlying asset. In most cases one option contract controls 100 shares. In contrast, for a put option, the strike is the price at which the option holder can sell an underlying asset.
The strike price is also known as the exercise price.
Key Points
- The strike is the price at which an option contract can be executed by the holder to buy or sell shares of stock at an agreed-upon price.
- Options are products that can’t deliver a fixed income; this value comes from the possibility that the option holder has to sell or buy an asset at a fixed price despite the market circumstances.
- The strike price is the most critical element of the option contract, is what determines if the agreement will be valuable or not for the investor.
Understanding Strike Prices
The strike is the price set in a derivatives contract, that allows and asset (usually stock, commodities or currency) to be traded at a fixed amount, notwithstanding the market’s valuation of this product. Option contracts can’t deliver a fixed income as their value. This is based on the possibility the option holder has to purchase the asset at an advantageous price.
These financial products are a safer alternative for investors compared to directly buying an asset and waiting for a price increase or short-selling.
If the value of the asset doesn’t appreciate in value, the investor has the option to not exercise the contract, as they would be able to buy the stock or asset in the open market for a better price. But if that happens, the investor would lose the money invested in purchasing the option contract.
For that reason, the strike becomes the critical variable of call and put profitability. For example, the buyer of call would have the option, but not the obligation, to buy the underlying asset, in most cases a stock, at the strike price, even if the current market price of that asset is higher. Similarly, a trader buying a put would have the right, not the obligation to sell the asset at the strike price, and his counterpart, the put writer, would be obliged to agree to the holder’s decision.
The strike price is set at the beginning when the contract is written. It tells the option holder the price that the asset would have to reach for the options contract to start gaining, what is referred to as in the money.
If the strike is more obtainable, the option writer will ask for a higher premium to reduce the odds that the holder has of profiting.
Strike Price Example
If a call contract is sold with a strike price of $45 and a premium of $2 per contract, in this scenario, at the expiration date, if the stock price lands at $50, this would be considered as an in the money call. The contract holder would exercise his right to buy the asset at $45, and sell it immediately at market price for a $5 profit. However, because the option buyer paid $2 for this option contract, they would obtain $3 in profit per contract purchased. Conversely, in the case that the stock is trading below $45, the call would be considered as out of the money, thus expire worthless for the investor. Here they would lose the $2 premium they paid to buy the option contact.
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