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What Is a Strike Price?

Without question, trading stocks and options can be complex! Between the various technical analysis techniques, the terminology, and the hundreds of conflicting opinions, the world may seem completely overwhelming. But like anything, to develop mastery and consistency, a trader or investor must have a strong foundation. We’ll be covering a foundational term today — strike price. 

If you are an options trading veteran, you likely heard this word hundreds, if not thousands of times. But, if you’re just starting out, it’s important to get familiar with its true meaning.

How Does Strike Price Work?

The strike price plays a key role in determining how your option contract plays out. Holds a deciding factor how much money you can make or lose on the trade. 

Depending on your strike price, you may be able to increase or decrease your risk profile per trade. Additionally, you can factor in the risk-reward payout. 

There are multiple strike prices on any given stock. Depending on your outlook on the market, you will choose the strike price that aligns your goals with your perspective. 

What Is a Strike Price in Simple Terms?

A strike price is a predetermined set value where a trader can buy or sell the underlying derivative contract. If you are trading call options, the strike price is where the underlying security can be bought. Whereas, if you are trading put options, it is where the underlying security can be sold. 

Who Sets the Strike Price?

The market sets the strike price of a given option. But, you as the buyer or seller can decide which contract you want to enter.

There are numerous strike prices set for a given stock, both above and below the current share value. This is known as the vertical axis, and you can select any strike price along this axis. 

How Is Strike Price Calculated?

Strike prices occur both above and below the current market value per share. Generally speaking, the strike price moves in fixed dollar increments, both above and below the market value. For example, if the current value per share is $50, you may see strike prices at $45.50, $47.50, $50, $52.50, $55, etc. 

What Is an Example of a Strike Price?

To further understand strike price, let’s visit a fictitious example. Assume company ABC is trading for $70 per share. If you previously purchased a call option for that stock, and the strike option on that contract was $55 a share, you’d be able to purchase that stock at $55 despite the current market value being $70 per share. 

Your profit would be $15 per share — the premium you paid for the contract, multiplied by 100, as each option block is 100 shares. 

What Is “Moneyness?”

“Moneyness” is another term that is commonly used in the world of options trading. “Moneyness” describes the delta between the current trading value and the strike price.

There are three main categories within the “moneyness” umbrella: 

  1. Out Of The Money: This occurs when the contract value is trading below the agreed upon strike price. 
  2. In The Money: If there is a positive value assuming the contract expired today, the option is known as being in the money. 
  3. At The Money: When an options contract has its stock trading at the same value as the strike. This describes a break even financial outcome if the trader were to sell.

How Do Strike Prices Affect Put Options?

Someone who bought a put option will be In-The-Money when the stock price is trading for below the strike price. Whereas they will be Out-of-Money if the given stock value is trading above the predetermined strike price. 

How Do Strike Prices Affect Call Options?

If the call option is trading for more than the price of a stock, it would not be in one’s financial best interest to exercise that option. For example, if you have a call option to purchase shares at $60 per share, but the price per share is currently $55 on the open market, there is no reason to pay more for those given shares. You can buy them on the public market and save $5. 

What Is Risk Reward Payoff?

Everyone has their own risk tolerance and desired reward payoff. Understanding and managing risk is critically important to developing a winning strategy. Unfortunately, there is not a one size fits all approach here.

Some people are willing to take on greater risk in hopes of receiving a greater return or profit. Whereas others are more conservative with how much risk they are willing to take. 

What Is the Difference Between Strike Price and Stock Price?

Keep in mind, the strike price is not the same as the stock value. The price of a stock is what a singular share is currently trading for.

If you are watching the price tape in live time, you’ll see the price of a given stock change frequently during trading hours. The price of a stock reflects the last price someone paid for a share of that given stock.  

Taking a Sip of Water From a Fire Hose 

The world of trading and investing in options is certainly complex and it can feel like information overload.

Understanding the foundation can help set you up for success. But, even after you’ve laid the foundation, you may still find yourself operating in the world of the unknown. Working with a Financial Advisor may help make sense of all the market noise one is faced with whenever investing in the market. 

Working with a financial advisor can be a great choice. A financial advisor  is not only a great resource to learn from, they can help you reach your financial goals. They will take a global view of your finances, identify any opportunities for improvement, and can put you on a financial plan that is aligned with your desires.