Exercise Price (Strike Price)

Exercise Price Strike Price Options Trading Financial Derivatives Call Options Put Options Securities Options Market
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

### What is the exercise price in options trading? - [ ] The current market price of the underlying asset. - [ ] The price at which an option was initially purchased. - [x] The predetermined price per share at which the option holder can buy or sell the underlying asset. - [ ] The financial penalty for not exercising an option. > **Explanation:** The exercise price, also known as the strike price, is the predetermined price per share at which the holder of a call or put option can buy or sell the underlying asset. This price is fixed when the option contract is created. ### In what scenario is a call option considered "in the money"? - [x] When the market price of the underlying asset is higher than the strike price. - [ ] When the market price of the underlying asset is lower than the strike price. - [ ] When the market price of the underlying asset is equal to the strike price. - [ ] When the option's expiration date is distant. > **Explanation:** A call option is "in the money" when the current market price of the underlying asset is higher than the strike price, meaning the option holder stands to gain by exercising the option. ### In what scenario is a put option considered "out of the money"? - [ ] When the market price of the underlying asset is higher than the strike price. - [x] When the market price of the underlying asset is lower than the strike price. - [ ] When the market price of the underlying asset is equal to the strike price. - [ ] When the option holder has not yet exercised the option. > **Explanation:** A put option is "out of the money" when the current market price of the underlying asset is lower than the strike price, meaning the option holder would not benefit from exercising the option. ### Who determines the strike price of an options contract? - [ ] The buyer of the option. - [x] It is predetermined when the options contract is created. - [ ] The underlying asset's company. - [ ] The stock exchange. > **Explanation:** The strike price is predetermined when the options contract is created and does not change during the lifespan of the contract. ### At what point can an options holder exercise their option? - [x] At any time before the expiration date of the option. - [ ] Only after the expiration date of the option. - [ ] Only at the time the option was purchased. - [ ] Within a grace period after the expiration date. > **Explanation:** Options can typically be exercised at any time before the expiration date, which is when the right to exercise the option lapses. ### What happens when a call option is exercised? - [ ] The holder sells the underlying asset at the strike price. - [x] The holder buys the underlying asset at the strike price. - [ ] The holder receives a dividend. - [ ] The option becomes void. > **Explanation:** When a call option is exercised, the option holder buys the underlying asset at the strike price. ### Can the strike price be changed once it is set? - [ ] Yes, it can change with market fluctuations. - [ ] Yes, the option holder can change it. - [ ] Yes, the issuer can decide to change it before expiration. - [x] No, the strike price is fixed when the option contract is written. > **Explanation:** The strike price is fixed when the option contract is established and cannot be changed. ### What type of option gives the holder the right to sell the underlying asset at the strike price? - [ ] Call option. - [x] Put option. - [ ] Forward contract. - [ ] Convertible bond. > **Explanation:** A put option gives the holder the right to sell the underlying asset at the strike price. ### Which factor does not directly influence the strike price of an option when it is created? - [x] The option holder's personal financial situation. - [ ] Volatility of the underlying asset. - [ ] Current market price of the underlying asset. - [ ] The expiration date of the option. > **Explanation:** The option holder's personal financial situation does not influence the strike price; it is based on market conditions, volatility, and the expiration date of the option. ### What is another term used interchangeably with the exercise price? - [x] Strike price. - [ ] Market price. - [ ] Option premium. - [ ] Spot price. > **Explanation:** The term "strike price" is used interchangeably with "exercise price."

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Tuesday, August 6, 2024
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