Exercise Price (Strike Price)

The exercise price, also known as the strike price or striking price, is the predetermined price per share at which an option holder can buy (in the case of a call option) or sell (in the case of a put option) the underlying security.
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Exercise Price (Strike Price)

Definition

The exercise price, also known as the strike price or striking price, is the price per share that the holder of an options contract can buy (in the case of a call option) or sell (in the case of a put option) the underlying asset. It is a fundamental concept in options trading and is predetermined when the option contract is written.

Examples

  1. Call Option Example: Suppose an investor buys a call option for Company XYZ’s stock at a strike price of $50. If the stock’s market price rises above $50, the investor profits by exercising the option to purchase the stock at $50 and potentially selling it at the market price.

  2. Put Option Example: An investor buys a put option for Company ABC’s stock at a strike price of $40. If the stock’s market price falls below $40, the investor profits by exercising the option to sell the stock at $40, despite the lower market value.

Frequently Asked Questions (FAQs)

  1. What is the difference between a call option and a put option?

    • A call option gives the holder the right to buy the underlying asset at the strike price, while a put option gives the holder the right to sell the underlying asset at the strike price.

  2. How is the strike price determined?

    • The strike price is determined when the option contract is created. It can be influenced by factors such as the current market price of the underlying asset, volatility, and expiration date.

  3. Why is the strike price important?

    • The strike price determines the value of an options contract and the potential profit or loss for the option holder. It is pivotal in calculating whether an option is “in the money” (profitable) or “out of the money” (not profitable).

  4. What happens when an option is exercised?

    • When a call option is exercised, the holder buys the underlying asset at the strike price. When a put option is exercised, the holder sells the underlying asset at the strike price.

  5. Can the strike price change during the life of the option?

    • No, the strike price is fixed when the option is written and cannot be changed.

  1. Options Contract: A financial derivative that represents a contract between two parties to buy or sell an asset at a specific price before a specified date.

  2. Underlying Asset: The financial instrument (e.g., stock, bond, commodity) on which an options contract is based.

  3. In the Money (ITM): A situation where an option has intrinsic value. For call options, when the current price of the underlying asset is above the strike price. For put options, when the current price is below the strike price.

  4. Out of the Money (OTM): A condition where an option lacks intrinsic value. For call options, when the current price of the underlying is below the strike price. For put options, when the current price is above the strike price.

  5. Expiration Date: The date on which an options contract becomes void and the right to exercise it no longer exists.

Online References

Suggested Books for Further Studies

  1. Options as a Strategic Investment by Lawrence G. McMillan
  2. Trading Options For Dummies by Joe Duarte
  3. Options, Futures, and Other Derivatives by John C. Hull

Accounting Basics: “Exercise Price (Strike Price)” Fundamentals Quiz

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