Strike Price: Definitions and Uses for Options Trading

An options strategy will define when, how and for what price you’ll enter an options trade. There’s plenty to consider here, including the differences between buying or selling calls and puts, as well as how options are priced. 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.

How a Strike Price Affects the Value of an Options Contract

However, an ITM call has a higher initial value, so it is actually less risky. OTM calls have the most risk, especially when they are near the expiration date. If OTM calls are held through the expiration date, they expire worthless.

Working with an adviser may come with potential downsides such as payment of fees (which will reduce returns). There are no guarantees that working with an adviser will yield positive returns. The existence of a fiduciary duty does not prevent the rise of potential conflicts of interest. SmartAsset Advisors, LLC (“SmartAsset”), a wholly owned subsidiary of Financial Insight Technology, is registered with the U.S. Knowing when to exercise an option can be tricky, and it hinges on both the strike price of the option and the timing.

Trading platforms

Setting a strike price depends on the amount of risk you want to take and how much you are willing to spend on purchasing the options. Options become at the money when the strike price and the stock price are the same. An option with a $70 strike price is at the money if the underlying stock is also valued at $70 per share.

Strike Prices in Different Types of Options

Here, the stock options strike price acts as a benchmark—the point where the tides turn in favor of the option holder. Should the market value rise above this strike price, the call option emerges in-the-money, presenting a lucrative “call” for the investor to buy at a previously agreed-upon lower price. So the strike price is the price at which the option goes in the money (i.e., has some value at expiration) or out of the money (i.e., is worthless). New options investors should consider adhering to some basic principles. They should refrain from writing covered ITM or ATM calls on stocks with moderately high implied volatility and strong upward momentum. Unfortunately, the odds of such stocks being called away may be quite high.

1. This indicates that if the stock stays above $20 before the expiration date of your call options, you could exercise your options and buy shares of ABC for $20.
2. What’s important to remember about trading options is that the contracts you hold give you the right to buy or sell, but you’re not obligated to do either.
3. So the strike price is the “fulcrum” on which the value of the option turns.
4. This relationship also indicates the potential returns you can generate.

In Carla’s case, GE should trade to $26.81 at most on expiry for her to break even. Next, decide whether to buy a call or write a put based on what you think is going to happen. Then, you need to decide on your strike price based on your risk tolerance and your desired risk-reward payoff.

What’s the Role of the Strike Price for Determining the Best Option?

The spot price is another term used for the current market price of the underlying security. The $40 put option has no value because the underlying stock is above the strike price. Remember that put options allow the option buyer to sell at the strike price. There’s no point using the option to sell at $40 when they can sell at $45 in the stock market so the $40 strike price put is worthless at expiration.

No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients.

Contrasting the strike price with the spot price brings to light the immediate cost of the underlying asset. The spot price is the real-time price at which the asset can be sold or bought, while the strike price is the fixed rate agreed upon within the options contract. These prices can diverge, affecting the potential for an option to be profitable and guiding trading strategies.

For example, suppose you are bearish Trade in tesla on company DEF and think that it will trade below $50 in three months. You could purchase put options and select a strike price between $50 to $70 depending on your risk tolerance. Options trading is a nuanced financial practice that brings complexity and strategy to the forefront, especially when it comes to understanding strike prices. Depending on the specific stock option in question, the strike price can take on various roles and signify different opportunities for investors and traders alike.

For a put writer, the wrong strike price would result in the underlying stock being assigned at prices well above the current market price. That may occur if the stock plunges abruptly, or if there is a sudden market sell-off, sending most share prices sharply lower. We can look at the current stock price to see which option has value if we have two put options, both about to expire, and one has a strike price of united states treasury security $40 and the other has a strike price of $50.

To pick a strike price, you’ll need to calculate several different scenarios using possible prices at option expiration to determine potential profits and losses if you hold the options until they expire. At-the-money options have strikes at or very close to the current market price and they’re often the most liquid and active contracts in a name. The question of what strike price is most desirable will depend on factors such What is the dow jones trading at as the risk tolerance of the investor and the options premiums available from the market. An option with a delta of 1.00 is so deep in-the-money that it essentially behaves like the stock itself. Examples would be call options very far below the current price and puts with strikes very high above it.

We do not manage client funds or hold custody of assets, we help users connect with relevant financial advisors. 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.

Finally, an option with a strike price at or very near to the current market price is known as at-the-money (ATM). ATM options are often the most liquid and active options traded in a name. This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result.

For example, suppose you want to purchase at the money call options of stock ABC and the stock price is currently trading at $20. Since you want to purchase at the money call options, you would set a strike price of $20. This indicates that if the stock stays above $20 before the expiration date of your call options, you could exercise your options and buy shares of ABC for $20. For pragmatic insights into strike price calculations, consider a call option. The call option strike price is selected based on the trader’s forecast of asset price appreciation. If an investor predicts an increase in the stock price of a company, they might select a strike price just above the current market value to capitalize on the expected growth.