The strike price is the predetermined price where an option holder can make a transaction. It is essentially the price where the contract holder is eligible to “strike” a deal.
Remember when you were younger and heard you couldn’t eat dessert until you finished dinner? Getting your dinner completed was the key to unlocking that delicious piece of the pie. In the same way, a stock achieving the strike price is the key to executing an option contract. An option contract cannot be executed unless the strike price is met.
To further explain, when a stock achieves a contract’s strike price, the holder of the option contract can now either buy the stock (call option) or sell the stock (put option):
The strike price is what you would pay per share if you decided to exercise your rights as a call option buyer and the price you would receive per share as a put option buyer.
How does Strike Price Impact Option Value?
The strike price is a critical factor in determining an options contract’s value. Since the deal cannot happen unless the strike price is met, options closer to the strike price will be more expensive, and inversely, options contracts that are further from the strike price will be more inexpensive.
The 3 Types of Strike Prices
Strike prices will fall into one of 3 categories, defined by “moneyness.”
- In-the-Money (ITM)
- At-the-Money (ATM)
- Out-of-the-Money (OTM)
Let’s look into each of these categories further.
In-the-Money (ITM) Strike Prices
If the strike price has been achieved and the buyer is eligible to exercise their option contract, the option is considered “in the money.”
When considering a call option, if the strike price is below the stock’s current market price, the option is In-the-Money because the holder of the option contract can buy the stock for less than the market value.
For a put option, if the strike price is above the stock’s current market price, it is also In-the-Money as the contract holder can exercise their rights and sell the stock for more than its market value.
At-the-Money (ATM) Strike Prices
If the strike price of an option is at the same level as the stock’s current market price, the option is considered “at the money.”
Being At-the-Money means that the option contract holder could exercise their rights and buy or sell the stock at the contract’s strike price, but since the strike price and the market price are the same, there would be no net profit from this transaction.
There is typically no reason to execute a basic call or put option that is At-the-Money since it will not be a profitable trade. Moreover, if you use a brokerage that charges fees per transition, you could even experience lost capital from executing this trade.
Out-of-the-Money (OTM) Strike Prices
If the strike price has not been achieved and the option contract has no intrinsic value, that option is considered “out of the money.” Therefore, executing an options contract that is far Out-of-the-Money is typically not a good idea as the option will not have intrinsic value. With this in mind, it may be a good idea to trade the option contract if the option contract holder wants to capture gains or cut losses.
Conclusion on Strike Prices
Picking the right strike price is one of the most important aspects of trading options. If you choose one that is too far Out-of-the-Money from the stock’s current market price, you run the risk of never being able to execute your contract (and the option expiring worthless). For beginners, it is recommended to stick with strike prices that are either already In-the-Money or At-the-Money to reduce risks. Unless you leverage advanced strategies, try to pick a strike price that looks attainable before the option reaches its expiration date.
What does strike price mean?
The strike price is the price a stock must achieve for the options contract holder to execute the deal. If the stock price has not yet met the strike price, the option holder can There are three categories of strike prices: In-the-Money (ITM), At-the-Money (ATM), and Out-of-the-Money (OTM).
What is the strike price formula?
When someone asks for the strike price formula, they are typically trying to figure out how to calculate the strike price. Strike prices are spaced at different intervals for ETFs, indices, and stocks. Most of the time, the strike prices are 5-points apart, but sometimes they may be 2.5-points apart for lower-priced stocks. The easiest way to determine strike price is by looking at available quote montages through your broker’s trading platform and online resources such as www.cboe.com.
What happens when you hit the strike price?
The options contract is eligible for execution when a stock hits the strike price. If you are the option contract holder, you can now “strike” a deal and execute your rights whether you have a call option or a put option.
How do you determine a strike price?
Similar to asking “what is the strike price formula,” strike prices are available on broker trading platforms by reviewing the quote montage of a stock.
Is a high or low strike price better?
The strike price you select will depend on many factors, including your option type (call or put), strategy, and expiration date. With this in mind, a “high” or “low” strike price will not be what determines if the strike you have selected is advantageous.
How do you compare the strike price vs. exercise price?
The strike price and the exercise price are the same. This is the price the stock (or asset) must achieve for the option contract to be exercised. If the stock does not meet this price, the option contract can be sold to another holder or remain with the current option contract holder until expiration.
How do you compare the strike price vs. stock price?
The stock price is the current market price that the stock is trading against, while the strike price is the price that the stock must achieve for an option contract to be exercised.