What Is a Strike Price?
In an option contract, the strike price is the agreed-upon price at which a specific security may be bought (in the case of a call option) or sold (in the case of a put option) by the option holder until or upon the expiration of the contract. The term “strike price” is used interchangeably with the term “exercise price.”
Options are derivative contracts that grant their buyers the right, or option—but not the obligation—to buy or sell a specific security (like a share of a company’s stock) at a specific price (the strike price) until or upon a certain date (the expiration date). Buying or selling the underlying security specified in an options contract is referred to as exercising an option. American-style options can be exercised any time after they are purchased until they expire, whereas European-style options can only be exercised upon maturity.
How Does the Strike Price Affect the Value of an Option Contract?
The strike price is the most important determinant of the value or price (premium) of an options contract. Other factors that affect contract value include the spot value (current market price) of the underlying asset, the volatility of the underlying asset, and the length of time until the contract’s expiration.
Because the holder of a call option has the right to buy the contract’s underlying asset, the lower the strike price, the more valuable the call option should be. In other words, the lower the strike price is compared to the spot price (the market value of the underlying asset at the time the contract is exercised), the more of a discount the call option holder can buy the asset at.
Because the holder of a put option has the right to sell the contract’s underlying asset, the higher the strike price, the more valuable the put option should be. In other words, the higher the strike price is compared to the spot price, the more of a profit the put option holder can make when they sell the underlying asset upon exercising the contract.
What Are the 3 Types of Strike Prices?
Options are categorized by whether their strike prices are above, below, or equal to the current market value of the underlying asset. In other words, they are categorized based on whether or not they have intrinsic value. Since spot prices (market values) change over time, but strike prices (as outlined in the terms of options contracts) do not, an option’s intrinsic value can change over the course of its contract. An option may fall into one of the three categories below at one point in time but move into one of the other categories at another point in time.
1. In-the-Money (ITM) Strike Prices
If the strike price of an option is such that its buyer could exercise the option for a profit or gain, that option is considered “in the money.”
In the case of a call option, if the strike price is below the spot price (current market value), that option is in the money because the holder could exercise the option by buying the underlying asset for a capital gain. A put option, on the other hand, is in the money if the strike price is above the spot price because the holder could exercise the option by selling the underlying asset for a profit.
TheStreet Dictionary Terms
2. At-the-Money (ATM) Strike Prices
If the strike price of an option is the same as the spot price (current market value), that option is considered “at the money” because exercising it would allow the holder to buy or sell the underlying asset at the same price as they could on the open market. Generally, there is no reason to exercise an option when it is at the money. In fact, because options contracts cost money to purchase, the holder of an ATM option contract would experience a small capital loss whether they exercised the option or simply let it expire.
3. Out-of-the-Money (OTM) Strike Prices
If the strike price of an option is such that its buyer would lose money by exercising it, that option is considered “out of the money.” There would be no point in exercising an OTM option, but some buyers might hold an OTM option in the hopes that the value of the underlying asset would change in their favor before the expiration of the contract.
In the case of a call option, if the strike price is above the spot price (current market value), that option is out of the money because the holder would experience capital loss if they exercised it. In the case of a put option, if the strike price is below the spot price, that option is out of the money because the buyer would sell the underlying asset at a loss if they exercised it.
Moneyness of Call and Put Options by Strike Price
|Strike Price Lower Than Spot Price||Strike Price Equal to Spot Price||Strike Price Greater Than Spot Price|
In the Money
At the Money
Out of the Money
Out of the Money
At the Money
In the Money
Additional Information About Strike Prices
- For any given security, strike prices for options are usually standardized, meaning they are only available at certain price intervals. Full dollar amounts (like $141, $142, $143, etc.) and half-dollar amounts (like 12.50, $13, $13.50, etc.) are common.
- Strike prices are typically set by options exchanges like the New York Stock Exchange (NYSE) and the Chicago Board Options Exchange (CBOE).
- The relationship between an option’s strike price and its spot price is one of several factors that affect the option’s premium (how much it costs to purchase the option). Just like other securities, options change in value over time.
- Options whose strike prices render them out of the money (OTM) or at the money (ATM) lose value more rapidly the closer they get to expiration. This process is known as “time decay.” Options whose strike prices render them in the money (ITM) experience time decay more slowly since they have intrinsic value.
Frequently Asked Questions (FAQ)
This section includes answers to some of the most commonly asked questions about strike prices and how they function in options contracts.
What’s the Difference Between Strike Price and Spot Price?
Spot price refers to a financial asset’s current market value, or how much it is presently being bought and sold for in the open market. Spot price changes constantly depending on how an asset is valued by the market.
Strike price refers to the price at which an option contract holder may buy (in the case of a call) or sell (in the case of a put) the contract’s underlying asset for upon or prior to the contract’s expiration. Since the strike price of an option is outlined in a contract, it does not change over time.
What’s the Best or Most Advantageous Strike Price?
For any given security, there is no best or most advantageous strike price for options contracts. Options whose strike prices are close to the underlying asset’s market value (spot price) carry less risk but are also less likely to result in large capital gains. Options whose strike prices are farther from the underlying asset’s market value are riskier and less likely to result in capital gains, but they can result in larger profits when exercised if the underlying security changes significantly in value in the right direction.
For risk-averse investors, options whose strike prices and spot prices are similar may be more appealing, while for investors who aren’t opposed to risky bets and are seeking larger returns, options whose spot prices are farther from their strike prices may be more desirable, especially if the underlying asset is known to be highly volatile (likely to change in price significantly over relatively short periods of time).