Options Strike Prices: What Are They and How Do They Work?
If you’re going to understand options, you’ve got to know what strike prices are and how they work. While the concept of a strike price in and of itself is not that complicated, the use of options strike prices can have hugely different ramifications depending on the type of options strategy you intend to employ. Here’s what you need to know about options strike prices to get started on the right foot.
What Is an Options Strike Price?
An option gives the holder the right to buy or sell a particular security before a specified time at a given price — that price is known as the strike price. If you buy a call option, the strike price is the price at which you have the right to buy the underlying security. If you own a put option, the opposite is true — you have the right to sell the underlying security at the option’s strike price.
Options Strike Price Example
An example would be that you buy a Tesla October call with a strike price of 200. That gives you the right to buy 100 shares of Tesla stock for $200 per share anytime before the option expires in October.
If Tesla stock moves up to $250 per share before October, for example, that option becomes quite valuable, as you’re entitled to buy those shares at $200 even though the market price is $50 higher.
The opposite would be true if you owned a Tesla October 200 put. If the stock moved to $250 per share, your options would expire worthless, because no one would want to sell Tesla at $200 per share when it could be sold for $250 in the open market.
In-the-Money vs. Out-of-the-Money
A call option, which gives the right to buy a stock at a given price, is in-the-money if the strike price is below the current market price. If the strike price of your call option matched the current market price of the underlying security, your option would be at-the-money.
For example, if Tesla is trading at $250 and you hold a 200 call option, your option is in-the-money by $50. This in-the-money amount is known as the “intrinsic value” of the option. If Tesla were to fall to $150 per share, your 200 strike price call option would be out-of-the-money, as it would have no intrinsic value because no one would pay $200 per share for Tesla if it were available in the open market for $150.
Time Value of an Option
Options have two forms of value: intrinsic value and time value. The longer until your option expires, the higher its time value, as it allows more time for the underlying stock to rise in value and exceed the strike price.
So, if your option has an intrinsic value of $50 but it expires in October and it’s only May, your option will also have a significant time value. But every day that your option gets closer to its expiration date, the time value will slowly waste away.
What Is Strike Price vs. Exercise Price?
An options strike price is also sometimes referred to as its exercise price. Although many options traders simply buy and sell options before they expire, some others actually exercise the option. When you exercise a call option, you physically buy the underlying stock at the option exercise price.
For example, if you hold that Tesla October 200 option and the stock trades at $250 per share in the open market, any time before that option expires in October you can exercise the option and physically buy 100 shares of Tesla stock at $200 per share. If you instead held a put option, you would have the right to put 100 shares of Tesla to another investor at $200 per share. However, in this scenario, you would not likely exercise that put option, as you’d be gifting another investor the right to buy Tesla stock for $50 below the current market price.
The Bottom Line
At the most basic level, a strike price tells investors the price at which an option can be exercised. However, strike price plays a number of other roles as well, including being a critical component of the intrinsic value of an option. Before you get too deeply involved with options trading, it makes sense to both speak with a financial advisor well-versed in options trading and to start your own paper portfolio to understand how options move without risking your own capital.
FAQHere are the answers to some of the most frequently asked questions regarding options strike prices.
- What is a strike price?
- When dealing with options, a strike price is the price you have specified to buy or sell a stock at.
- What happens when a stock hits the strike price?
- When the stock price hits the strike price, the option is at-the-money and has no value.