The strike price of an option is the price at which a put or call option can be exercised. Picking the strike price is one of two key decisions (the other being time to expiration) an investor or trader must make when selecting a specific option. The strike price has an enormous bearing on how your option trade will play out. In general, the strikes will be wider for stocks with higher prices and with less liquidity or trading activity. New strikes may also be requested to be added by contacting the OCC or an exchange.
The moneyness of an option refers to the position of the market price of the underlying asset relative to the option’s strike price. Options that are “in the money” have intrinsic value and represent a profitable exercise scenario for the holder, assuming the position was to be closed in the market. The precise understanding and application of the moneyness concept guide traders towards more informed and potentially lucrative trades. In-the-money calls with a strike price of $120 had a bid price of $65.40. Since options contracts represent $100 shares, traders were willing to pay $6,540 for the right to purchase 100 shares of Tesla if the stock’s price dipped to $120 per share.
Options are only good for a set period of time, after which the option expires. For example, a call option would specify the option’s strike price and expiration date – say, December 2023 and $45 – or what traders might call December 45s. An option is the right, but not the obligation, to buy or sell a stock (or some other asset) at a specific price by a specific time. An option has a fixed lifetime and expires on a specific date, and then the value of that option is settled among its buyer and seller. The option expires with either a definite value or worthless, and the strike price is the key to determining that value.
That means that while you have the autonomy to pick a strike price, you cannot directly set that strike price yourself. Those who are new to options should also be wary of writing covered ITM or ATM calls with volatile underlying assets heading to the moon. Having to deboard the rocket at takeoff would be more than disappointing.
- If we have two put options, both about to expire, and one has a strike price of $40 and the other has a strike price of $50, we can look to the current stock price to see which option has value.
- If you think the stock will continue to gain value, then you’d want to buy a call option with a strike price that’s below what you think the stock’s price will eventually reach.
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- The risk of assignment increases if the option is deep-in-the-money and close to expiration.
- So, the trader bought an OTM put option of MUDS with a strike price of $12.50.
But the strike price you choose, along with the expiration date, will determine the level of risk you assume. Similarly, for the put options, if the Nifty50 is trading at 16,200— the 16,200 strike price will be termed “at the Money” (ATM). The 16,100 strike price will be referred to as “out of the Money” (OTM), and the 16,300 strike price will be known as “in the Money” (ITM). Options trading can be an attractive investment strategy, because if done correctly, you can potentially make money when a stock is going down as well as when it goes up. In options trading, terms such as in-the-money, at-the-money and out-of-the-money describe the moneyness of options. In contrast, to determine whether an options trade was profitable, you would have to subtract the price you paid from your total proceeds.
How We Make Money
For example, the premium will decrease as the options contract draws closer to its expiration since there’s less time for an investor to make a profit. The strike price considerations here are a little different since investors have to choose between maximizing their premium income while minimizing the risk of the stock being “called” away. Therefore, let’s assume Carla writes the $27 calls, which fetched her a premium of $0.80.
Successfully trading options means knowing which way you expect a stock or underlying security to move, how high or low you anticipate the price going and how long you want to keep the contract in place. If a stock is trading below its strike price, you could choose to sell it to make a profit. So say you buy a put option for the same stock with a strike price of $15. Even if the stock’s price dips to $10 you could still sell your shares for $15 each to realize a profit of $5 per share. 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).
Then, the two most important considerations in determining the strike price are your risk tolerance and your desired risk-reward payoff. For buyers of the call option (such as in the example above), if the strike price is higher than the underlying stock price, the option is out-of-the-money (OTM). Conversely, If the underlying stock price is above the strike price, the option will have intrinsic value indices meaning in trading and be in-the-money. 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. The call option is synonymous with the anticipation of an increase in the underlying asset’s value. Here, the stock options strike price acts as a benchmark—the point where the tides turn in favor of the option holder.
So before you purchase one you’ll know exactly what price you could buy or sell an underlying asset for. On the surface, selling a covered call against such a stock might seem contradictory to the desire to hold. Nevertheless, some investors sell covered calls against such stocks for the purpose of bringing in incremental income. The strategy type helps determine how aggressively you want to set up the strike price; higher reward trades typically involve more risk.
Call Option and its Connection with Strike Price
The time to expiration and volatility inputs indicate how likely it is for an option to finish in-the-money before it expires. The more time there is to go, and/or the more volatile the underlying price moves are, the more likely that the market price will reach the strike price. Volatile moves happen due to acquisitions, earnings reports, company news, and other factors. Therefore, options with longer times until expiration and those with greater volatility will have higher premiums.
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Carla and Rick both own GE shares and would like to write the March calls on the stock to earn premium income. Generally, strikes $1.00 apart are the tightest available on most stocks. Due to stock splits or other events, you may have strikes that result in $0.50 or tighter. 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).
Calls and Puts
Since the option is ITM, the premium is $235 (2.35 x 100), $220 more than Kathy’s premium. OTM options, especially if they are near expiration, carry the most risk. And since OTM are less expensive than ATM and ITM https://g-markets.net/ options, the less the trader will lose if the option expires without value. Now suppose a trader recently read the S&P would have a gold-nugget open so decided to buy shares of the S&P exchange-traded fund SPY.
The $40 put option has no value because the underlying stock is above the strike price. Recall that put options allow the option buyer to sell at the strike price. There is no point using the option to sell at $40 when they can sell at $45 in the stock market. Expiration dates are the ticking clock in options trading, imposing a timeframe for exercising options. As such, they play a pivotal role in influencing an investor’s decision-making process. The closer an in-the-money option gets to its expiration date, the more pressing it becomes for an investor to exercise, lest they forego the built-in value of the option.
Writing a Covered Call ✍️
Other options contracts may have expiration dates that are months or even years in the future. The strike price is a key variable in a derivatives contract between two parties. Where the contract requires delivery of the underlying instrument, the trade will be at the strike price, regardless of the market price of the underlying instrument at that time. The strike price is important for calculating tax owed on employee stock options. Employees who receive statutory stock options as part of an incentive option plan don’t pay tax when the option is received or exercised. However, when the stock purchased using the option is sold, the strike price of the option is the cost basis used to calculate taxes owed.
