Options Strike Prices: How It Works, Definition, and Example

This risk increases when the strike price is set further out of the money. In the case of a call writer, the wrong strike price for the covered call may result in the underlying stock being called away. That gives them a higher return if the stock is called away, even though it means sacrificing some premium income. Puts with strike prices higher than the current price will be in-the-money because you can sell the stock higher than the market price and then buy it back for a guaranteed profit. A put option will instead be in-the-money when the underlying stock price is below the strike price and be out-of-the-money when the underlying stock price is above the strike price. It plays a crucial role in determining the value and profitability of options contracts.

How Does an Option Hit the Strike Price?

However, the strike price is one of the most critical factors in determining the value of an options contract. Conversely, if the strike price is higher than the current market price of the underlying asset, the call option is “out of the money,” and the put option is “in the money.” It means that the strike price is essential in determining an option’s moneyness and is a necessary component for calculating the break-even point and profit or loss for all options positions. A strike price is an anchor price (fixed, predetermined) around which the trade revolves. In the screengrab below – taken from our trading platform – you can see our option deal ticket for the Dow Jones Industrial Average (Wall Street) for 24 September 2020. You’ll see that the price of options is affected by whether the strike price is currently closer or further away from the underlying market price – circled in red at the top.

Discover the range of markets and learn how they work — with IG Academy’s online course. Marc Guberti is an investing writer passionate about helping people learn more about money management, investing and finance. He has more than 10 years of writing experience focused on finance and digital marketing. An option’s delta is how much its premium will change given a $1 move in the underlying security. A call with a +0.40 delta will rise by 40 cents if the underlying rises by a dollar.

Strike Price and Option Delta

Usually, traders use the term ‘exercise price’ while exercising the option closer to the expiry of the contract. But, let’s say that instead of rising to 125, the underlying market price had actually fallen to 115. This would mean that the option would expire worthless because the underlying market price has not exceeded the strike price of the call option. Delta measures how an option contract’s value changes for every $1 increase or decrease in the underlying asset.

Understanding the Strike Price of an Option

That may occur if the stock plunges abruptly, or if there is a sudden market sell-off, sending most share prices sharply lower. However, a lower strike price also means that the company is offering the employee a larger potential profit, which can be costly for the company if the stock price rises significantly. The strike price of employee stock options is typically set at the market price of the company’s stock on the grant date. The employee has the right to purchase the stock at the strike price at a later date, typically after a vesting period has elapsed. In the derivatives market, both strike price and exercise price hold the same meaning.

However, if the conversion price had been set at $2 per share, the investors would receive only 500,000 shares, resulting in a total value of $5 million for their investment. If the strike price is too low, the investors will receive a more significant ownership stake in the startup when they convert their investment into equity. Similarly, for the put options, if the Nifty50 is trading at 16,200— the 16,200 strike price will be termed “at the Money” (ATM). The 16,100  strike price will be referred to as “out of the Money” (OTM), and the 16,300 strike price will be known as “in the Money” (ITM). Trading options with us means that you’ll be speculating on the price of the option rising or falling, rather than buying or selling them directly.

In this case, since the market price of the stock is lower than the strike prices for both Carla and Rick’s calls, the stock would not be called. The prices of the https://forexanalytics.info/ March puts and calls on GE are shown in Tables 1 and 3 below. We will use this data to select strike prices for three basic options strategies—buying a call, buying a put, and writing a covered call. They will be used by two investors with widely different risk tolerance, Conservative Carla and Risky Rick.

As such, they play a pivotal role in influencing an investor’s decision-making process. The closer an in-the-money option gets to its expiration date, the more pressing it becomes for an investor to exercise, lest they forego the built-in value of the option. An option is out of the money when the stock price is in an unfavorable position relative to the strike price. For calls, an option is out of the money when the stock price how to use the accelerator oscillator is below the strike.

For puts, an option is out of the money when the stock price is above the strike. An option is in the money when the stock is in a favorable position relative to the strike price. For puts, an option is in the money when the stock price is below the strike price.

Example of an Options Contract

1. However, an ITM call has a higher initial value, so it is actually less risky.
2. While we strive to provide a wide range of offers, Bankrate does not include information about every financial or credit product or service.
3. Traders need to strike a balance between paying too much for an option contract and choosing a strike price that is too far out-of-the-money.
4. Options contracts become worthless if they are out of the money at expiration.

Finally, don’t think that you make money only when an option is in the money. Many low-risk options strategies revolve around selling options that will eventually be out of the money. For example, using the December 2024 $45 call option from before, the option would be worth $5 per contract if the underlying stock finished expiration in December at $50, or $50 minus $45.

The strike price is the price at which an employee can purchase company stock in the context of employee stock options. A lower strike price can make employee stock options more valuable to the employee, but it can be costly for the company if the stock price rises significantly. In conclusion, the strike price is critical to many financial instruments, including options contracts, convertible securities, and employee stock options. These factors are considered by the options market makers who set the strike prices for different options contracts.

Grasping the fundamentals of options trading starts with understanding the strike price definition. In the realm of financial markets, the strike price meaning is the cornerstone of any option contract, whether you’re dealing with a call option or a put option. It represents a specified price level, crucial for investors in determining their potential for profit or loss.

That’s the attractive nature of these contracts, and if they become in the money, these contracts can yield significant profits. By paying a premium, you can leverage options to hedge against potential losses, speculate on price moves, or generate income. An options contract is a financial agreement that grants the buyer the right, but not the obligation, to buy or sell a particular asset (like a stock) at a preset price within a given period. As financial markets have grown increasingly complex and, at times, more volatile, options have emerged as a potent way to guard against uncertainty and capitalize on price changes. In just a couple of decades, options, with their ability to leverage gains, manage risk, and strategic flexibility, have moved from an esoteric tool for professionals into a mainstream vehicle.

If you only want to stake a small amount of capital on your call trade idea, the OTM call may be the best option. Out-of-the-money options don’t have intrinsic value but they still contain extrinsic or time value because the underlying may move to the strike before expiration. Calls with strikes that are higher than the market or puts with strikes lower than the market are instead out-of-the-money (OTM) and only have extrinsic value, also known as time value. In that case, the investors will receive 1 million shares of the startup when they convert their investment into equity. In this scenario, the Nifty50’s 16,200 call option strike will be termed an “at the money” (ATM) option.