What is a Strike Price?

//What is a Strike Price?
What is a Strike Price? 2017-10-10T08:02:18+00:00

Definition: The strike price, also known as the exercise price, is the stock price that an option contract is exercised at allowing shares can be purchased or sold. This is one of the most important elements of options pricing because it reflects the risk associated with underlying asset hitting that value or falling short. If the stock hits that value, the option can be exercised. If it doesn’t hit that value, it will become worthless.

What Does Strike Price Mean?

What is the definition of strike price? The strike price differs for each agreement and depends on the market price and the underlying asset. For call options, the strike price is the price that the option holder can buy or sell the underlying asset in maturity. The exercise price can be exercised “in the money” or “out of the money.”

The term in the money means the market price is higher than the exercise price when it matures, and the buyer can exercise the option and buy the 100 shares at the given exercise price. Out of the money, on the other hand, means that the market price is lower than the exercise price when the option matures, and the buyer loses the money paid for the agreement.

Let’s look at an example.

Example

Maria buys a call option on the shares of company Z at a exercise price of $6. This means that Maria has the right to exercise her option and buy 100 shares of company Z at maturity for $600.

If the stock price increases to $12 before maturity, Maria exercises her option in the money as the exercise price of $6 is lower than the $12 market price. So, Maria can buy 100 shares of company Z for $6 per share and sell them for $12 per share in the open market, thus realizing a profit of ($12 x 100) – ($6 x 100) = $1200 – $600 = $600. At maturity, the difference between the market price and the exercise price is the profit earned by exercising the option.

If the market price falls to $4 at maturity, Maria loses her $600 that she initially paid to buy the shares at the strike price of $6. The seller maintains the shares. This is why the exercise price is one of the most important elements in prices index options, call options, and put options.

Summary Definition

Define Strike Price: A strike price is contracted price that an option can be exercised allowing the owner to purchase or sell shares of stock.