Strike prices, also known as exercise prices, are terms commonly associated with options trading. Options are financial instruments that give investors the right, but not the obligation, to buy or sell an underlying asset at a specified price (the strike price) before or at the option’s expiration date.
There are two types of options: call options and put options.
- Call Options:
- Strike Price for Call Options: This is the price at which the option holder can buy the underlying asset if they choose to exercise the option. If the market price of the underlying asset is higher than the strike price, the call option is said to be “in the money.”
- Put Options:
- Strike Price for Put Options: This is the price at which the option holder can sell the underlying asset if they choose to exercise the option. If the market price of the underlying asset is lower than the strike price, the put option is considered “in the money.”
Options contracts have expiration dates, and the strike price, along with the market price of the underlying asset at the time of expiration, determines the profitability of the option for the holder.
Here’s a brief breakdown:
- In the Money (ITM): For a call option, if the market price is above the strike price. For a put option, if the market price is below the strike price.
- At the Money (ATM): The market price is equal to the strike price.
- Out of the Money (OTM): For a call option, if the market price is below the strike price. For a put option, if the market price is above the strike price.
Call Options:
- In the Money (ITM):
- If you hold a call option with a strike price of $50 and the current market price of the underlying stock is $60, the option is considered in the money. This means you have the right to buy the stock at $50 (the strike price), which is lower than the current market price.
- At the Money (ATM):
- If the strike price of a call option is equal to the current market price of the underlying stock, it is at the money. For example, if the stock is trading at $50, and you hold a call option with a $50 strike price, it is at the money.
- Out of the Money (OTM):
- If the market price of the underlying stock is below the strike price of a call option, the option is out of the money. For instance, if the stock is at $40, and you hold a call option with a $50 strike price, it is out of the money.
Put Options:
- In the Money (ITM):
- In the case of a put option, it is in the money if the market price of the underlying stock is below the strike price. For example, if the stock is trading at $40, and you hold a put option with a $50 strike price, you have the right to sell the stock at $50, which is higher than the current market price.
- At the Money (ATM):
- A put option is at the money if the strike price is equal to the current market price. Using the previous example, if the stock is trading at $50, and you have a put option with a $50 strike price, it is at the money.
- Out of the Money (OTM):
- A put option is out of the money if the market price of the underlying stock is higher than the strike price. Continuing with the example, if the stock is at $60, and you hold a put option with a $50 strike price, it is out of the money.
Option Strategies:
- Covered Call:
- This strategy involves holding a long position in the underlying asset while simultaneously writing (selling) call options on the same asset.
- Protective Put:
- Investors use this strategy to protect themselves from a decline in the price of the underlying asset. It involves buying a put option while holding a long position in the asset.
- Straddle:
- This involves buying both a call and a put option with the same strike price and expiration date. It’s used when investors expect significant price volatility but are uncertain about the direction of the price movement.