What is Strike Price?

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Options contracts are derivatives that give the holders the right, but not the obligation, to buy or sell some underlying security at some point in the future at a pre-specified price. This price is known as the option's strike price (or exercise price). For call options, the strike price is where the security can be bought by the option holder; for put options, the strike price is the price at which the security can be sold.An option's value is informed by the difference between the fixed strike price and the market price of the underlying security, known as the option's "moneyness."For call options, strikes lower than the market price are said to be in-the-money (ITM), since you can exercise the option to buy the stock for less than the market and immediately sell it at the higher market price. Likewise, in-the-money puts are those with strikes higher than the market price, giving the holder the right to sell the option above the current market price. This feature grants ITM options intrinsic value.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).

Definition

The exercise price (also known as the strike price) is the price specified in an options contract at which the option holder can buy or sell the underlying security at a future date. For call options, the exercise price is the price at which the holder can purchase the security; for put options, it is the price at which the security can be sold.

Origin

The concept of the exercise price originated with the development of the options market. Options, as a type of financial derivative, can be traced back to the 17th-century Dutch tulip mania, but the modern options market was established with the founding of the Chicago Board Options Exchange (CBOE) in 1973, where the exercise price became a key element of options contracts.

Categories and Features

The exercise price can be categorized into 'in-the-money', 'out-of-the-money', and 'at-the-money'. An in-the-money option is when a call option's exercise price is below the market price, or a put option's exercise price is above the market price, giving it intrinsic value. An out-of-the-money option has an exercise price that is not favorable for immediate profit, having only time value. An at-the-money option is when the exercise price equals the market price.

Case Studies

Case 1: Suppose Apple's (AAPL) stock is currently priced at $150, and an investor holds a call option with an exercise price of $140. This option is in-the-money because the investor can buy the stock at $140 and sell it at the market price of $150, making a profit of $10 per share. Case 2: Suppose Tesla's (TSLA) stock is currently priced at $700, and an investor holds a put option with an exercise price of $750. This option is in-the-money because the investor can sell the stock at $750 while the market price is only $700, making a profit of $50 per share.

Common Issues

Investors often misunderstand the relationship between the exercise price and the market price, thinking all options should be exercised immediately for profit. In reality, out-of-the-money options are typically not exercised as it would result in a loss. Additionally, investors should be aware of the option's expiration date, as unexercised options will lose their value upon expiration.

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