- The strike price is the predefined price at which a derivatives holder has the right to exercise their option
- Derivatives are those financial instruments whose value is derived from the underlying asset
- The strike price is the most crucial determinant of the value of an option
What is the Strike Price?
The strike price is the predefined price at which a derivatives holder has the right to exercise their option. Hence, it is also called the exercise price. The strike price is used in derivatives trading. Strike price, when used in the context of call option, means the price at which the option holder can buy the security. When the strike price is used in the context of a put option, it denotes the price at which the option holder can choose to sell the security.
Irrespective of the spot price of an underlying security, say, a stock, a trader with a call option on the shares with a strike price of Rs 150 will have the right to buy the shares (specific volume as well) at Rs 150 during or at the end of the contract.
Significance of Strike Price
Strike prices are used in the context of derivatives trading. Derivatives are those financial instruments whose value is derived from the underlying asset. The strike price is a crucial variable of both call and put options. The call option buyer will have the right (not obligation) to buy the stock at the strike price in the future. Similarly, a put option buyer will have the right (not obligation) to sell the stock at the strike price in the future.
The strike price is an important factor determining the option value. The strike price is designated at the time when a contract is written. It suggests the price that the underlying asset has to reach for the option to be in-the-money or ITM. The difference in price between the strike price and the price of underlying stock determines the value of an option.
Strike Price Example
Let’s assume that there are two call option contracts. One has the strike price of $150, the other has the strike price of $200, and the underlying stock has a current value of $175. Assume that both the options are the same with only difference in the strike price. The first contract is in the money by $25, and the second contract is out-of-the-money by $25. If the underlying asset’s price remains below the strike price of the call option, the option is worthless upon expiration.