03) Strike Prices

by · January 3, 2015

In this lesson we’ll be talking about “strike prices”.  A strike price is defined as the price at which the given options contracts may be exercised.

With call contracts, it’s the price at which the options trader may buy the underlying stock at the time of expiration.  With put contracts, it’s the price at which the options trader may sell the underlying stock at the time of expiration.

Strike price is also referred to as “exercise price.”

Why Are Options Prices Different for Different Strike Prices?

CALL option contract prices have an inverse correlation to the strike price.  Therefore call contract prices increase in price as you decrease in strike price.

PUT option contract prices have a direct correlation with the strike price.  Therefore put contract prices increase in price as you increase in strike price.

In both cases, the increase or decrease in price is due to the 2 main things.  The option contract’s,…

  1. Intrinsic Value which is the “in the money” value of the given option.  So, if you were to buy a call contract where the underlying stock is trading at  $100 and you choose a strike price of $90 then the intrinsic value of your call options would be $10.
  2. Extrinsic Value which is sometimes called the time value.  The further out the expiration date of the given options contract, the greater the extrinsic value will be.

The option contract cost or “option premium” is equal to the intrinsic value + the extrinsic value.

 

What Strike Price Should I Choose?

This is mostly dependent upon your specific trade strategy.

The safer (less risk, less reward) strategy is to choose a strike price that is more in-the-money.  And the more aggressive strategy (more risk, more reward) is to choose a strike price more out-of the money.

And, here’s a quick refresher on what in-the-money means.

For CALLS: Underlying Stock’s Price >= Strike Price

For PUTS:   Underlying Stock’s Price <= Strike Price

 

And, here’s a quick refresher on what out-of-the-money means.

For CALLS: Underlying Stock’s Price < Strike Price

For PUTS:   Underlying Stock’s Price > Strike Price

 

Can I Sell My Contracts if the Strike Price is Not In-The-Money?
Yes, you may sell your contracts whether or not they are in-the-money any time before expiration.  If they are NOT in-the-money at expiration, they will expire worthless.