What is a Strike Price?

Definition:

An option is a contract to buy or sell an asset at a predetermined price before a specific date — That predetermined price is called the strike price.

🤔 Understanding a strike price

When you buy an option, you purchase the right to buy or sell a specific security at a predetermined price before a specific date. The predetermined price is called the strike price, or exercise price.

The relationship between the strike price and the price of the underlying asset determines whether the option is “in-the-money,” “at-the-money,” or “out-of-the-money.” It is this relationship that ultimately determines whether an option is worth anything at its expiration.

Example

Believing that Company A will deliver a strong quarter, you decide to purchase a call option. This contract gives you the right, but not the obligation, to buy 100 shares of Company A at a price of $50 before a specific date.

With Company A’s stock currently trading for $45, your call option is ‘out-of-the-money.’ This is because the strike price for your call option is above the current price of the stock. If you decided to buy the stock right then and there, you wouldn’t exercise your right to buy the stock at $50 using your call option. Rather, when you would be better off buying shares at the current price of $45.

However, if the stock rises above $50 — that’s the strike price of the contract — your option would be ‘in-the-money.’ In this scenario, it would now make sense to exercise your call option if you wanted to buy shares of the stock. This is because you can buy them at $50, which would be lower than the current market value of the stock.

If the stock was trading exactly at $50, your $50 call option would be considered “at-the-money.” This doesn’t give it any particular value, other than to denote it is the closest strike price to the current price of the stock. If Company A’s stock closed exactly at $50 on expiration day, the $50 call option would technically be “out-of-the-money” and expire worthless.

Takeaway

Strike prices are the proverbial “line in the sand.”

An option’s value at expiration is determined by whether or not the stock’s price has crossed that line and by how much. For call options to have value at expiration, the stock price must be above the strike price. For put options, the stock must move below it. If you decide to exercise your option, the line in the sand is where you plant your flag to buy or sell shares of the stock.

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How are strike prices calculated?

The strike price for an option that trades on an exchange isn’t something you have to calculate. The exchange where the option trades will set the strike price on an option when the options contracts get listed on that exchange.

In practice, there are usually standard strike price intervals for securities that have active options markets. Generally, 2 1/2 points when the strike price is between $5 and $25, 5 points when the strike price is between $25 and $200, and 10 points when the strike price is over $200. However, these intervals can and will vary based on a number of factors.

What is the difference between a strike price and a stock price?

The price of a stock is how much you can buy or sell a stock for.

The strike price is related, in that it’s the price at which you agree to buy (in the case of a call option) or sell (in the case of a put option) the underlying stock. However, the strike price of an options contract is set by an options exchange at the time the options contracts get listed on that exchange. Unlike stock prices, which change regularly, the strike price of an option does not change unless the underlying stock has a stock split or pays a stock dividend.

What is the difference between a strike price and a spot price?

Spot price is another term for the price of a security, though you’ll typically see it used for commodities like gold or oil.

The spot price of a security is the price at which you can currently purchase or sell the security in what is referred to as “the cash market.”

Why do strike prices matter?

The strike price of an option matters because it plays a significant role in determining the value of an option. There are other factors like time and implied volatility that can affect an option’s price, however at expiration, an option will only have value if it is “in-the-money.”

Do strike prices matter if I don’t want to exercise an option?

Yes, the strike price of an option matters, even if you have no intention of exercising the option to buy or sell the underlying security. If you don’t want to exercise an option for any reason, you have two choices:

One choice is to let the option expire. Options contracts have an expiration date attached. Once that date is reached, the contract is no longer valid, and it cannot be exercised. Keep in mind options that are in-the-money by one cent or more will be automatically exercised by the Options Clearing Corporation.

The other choice is to sell the contract. You’re free to sell an option contract that you own at any time (assuming there is a willing buyer). Like the price of a stock, the price of an option contract changes regularly. The strike price of the option, the price of the underlying security, the expiration date, and supply and demand all affect the value of an option.

Even if you plan on selling the option before it expires, the strike price matters because it will play a big role in determining the price of your option.

What is a put option, and how does the strike price affect it?

A put option is an option to sell an asset or security at a predetermined price by a certain date.

The strike price affects a put option by determining the price at which the option holder can sell the underlying asset.

In general, put options become more valuable when the strike price is above the price of the stock. In this scenario the buyer of the put option can sell shares for a higher price than the where the stock is currently priced.

How does the strike price affect a call option?

A call option is an option to buy an asset or security at a predetermined price by a certain date.

Generally, call options are more valuable when the strike price is below the price of the stock. In this scenario, the option holder can exercise the option to purchase the stock at a discount to its market price.

What does it mean for an option to be in-the-money, at-the-money or out-of-the-money?

When discussing options trading, you’ll often hear people talking about options that are “in-the-money,” “at-the-money,” or “out-of-the-money.”

An option that is in-the-money is an option that has an intrinsic value, rather than a value that is caused by the potential for a stock’s price to change before the option expires (time value).

For a call option, that means that the strike price is below the stock’s current price. That lets the option holder exercise the option and buy shares at a discount to the current market price.

For a put option, that means that the strike price is above the stock’s current price. The option holder can exercise the option and sell shares at a premium to the current market price.

“At-the-money” has the same meaning for puts and calls and indicates that the strike price and the actual price are the same. Although options traders will often refer to the options strikes closest to the current stock price as the “at-the-money” call or put.

An “out-of-the-money” option has no intrinsic value. The option holder couldn’t exercise the option and potentially make a profit.

That does not mean that out-of-the-money options are worthless. Stock prices change frequently, so there is always the possibility that an out-of-the-money option will turn into an in-the-money option as prices change. This gives some value to options that are out-of-the-money.

Some people will choose to sell options, instead of buying them. Options sellers are trying to take advantage of the fact that out-of-the-money options have a lower probability of expiring in-the-money. By selling these options, people can make money by collecting the premium paid for those options. If these options become in-the-money, the option sellers can end up losing money, and in some cases be assigned on the option they sold. If they sell a call, they are obligated to sell shares at the strike price. And if they sold a put, they are obligated to buy shares at the strike price.

Keep in mind, options trading has significant risk and isn’t appropriate for all investors — and certain complex options strategies carry additional risk. To learn more about the risks associated with options trading, please review the options disclosure document entitled Characteristics and Risks of Standardized Options, available here or through https://www.theocc.com. Investors should absolutely consider their investment objectives and risks carefully before trading options. Supporting documentation for any claims, if applicable, will be furnished upon request.

Examples are hypothetical, and do not reflect actual or anticipated results, and are not guarantees of future results.

Ready to start investing?
Sign up for Robinhood and get your first stock on us.Certain limitations apply

The free stock offer is available to new users only, subject to the terms and conditions at rbnhd.co/freestock. Free stock chosen randomly from the program’s inventory. Securities trading is offered through Robinhood Financial LLC.

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