What is Strike Price?

What is Strike Price?
Strike Price

In options, each one has a strike price, which is the set price at which the underlying asset can be bought or sold if the option is exercised. In the case of a call option the strike price is where the underlying asset can be purchased, and in the case of a put option the strike price is where the underlying asset can be sold. Strike price is also known as the exercise price.

Summary of Strike Price

  • The strike price is the price at which the underlying asset to an option can be bought (calls) or sold (puts.
  • Options are a type of derivative financial product whose value is based (derived) on the price of some underlying asset.
  • In the case of options, the strike price is the most important variable in determining the value of the option.

Strike Prices Explained

Strike prices are primarily used in options trading, but there are other less used financial derivatives that also use strike prices. The value of options and other derivatives is based on (derived) the price of some underlying asset, usually another financial product. The strike price is the most important variable in an option. With a call option the strike price is the price at which the holder has the right (but not the obligation) to purchase the underlying asset the option is based on. In the same way with a put option the strike price is the price at which the holder has the right (but not the obligation) to sell the underlying asset the option is based on.

While there are many variables that go into determining the price of an option, the strike price is the most important of these variables. The strike price is set for the option when it is written and never changes during the life of the option. It lets investors know what price the underlying asset needs to reach for the option to have an intrinsic value and to be considered in the money. Strike prices are standardized and are set at fixed dollar amounts, most typically in $5 increments.

The difference between the strike price and the price of the underlying asset is what determines the value an option holds. In the case of call options, as long as the strike price of the option is below the current market price of the underlying asset the option is considered to be in the money. This is when the option has some intrinsic value. If the price of the underlying asset drops below the strike price of a call then it is considered out of the money (OTM) and has no intrinsic value, but it may still have some value based on volatility and the time left until the option expires. In some cases, these factors can put an option in the money (ITM) without any intrinsic value. In the case of a put option the option is considered to be in the money when the strike price of the option is higher than the current market price of the underlying asset.

Strike Price Example

Let’s say there are two call options, one with a strike price of $75 and the other with a strike price of $100. The current market price of the underlying asset is $90. Aside from the difference in the strike price everything else about these two call options is the same. At the expiration of the options the first one is worth $15, or is considered to be in the money by $15. That’s because its strike price is $15 below the current price of the underlying asset. The second contract is out of the money by $10 because its strike price is $10 above the current market price of the underlying asset. This contract is out of the money and will expire worthless.

We could also look at a similar situation where we have two put options. The first has a strike price of $50 and the second has a strike price of $60. Other than the different strike prices everything about these options is the same. If the current market price of the underlying asset is $55 the put option with the strike price of $60 has $5 intrinsic value because the strike price is $5 above the current market price of the underlying asset. The $50 put option is worthless because its price is below the current market price of the underlying asset. Remember that the put option gives the holder the right to sell the underlying asset at the strike price. There’s no point in doing this when the price of the asset is already higher than the strike price of the put option. The $50 strike option will expire worthless.