Definition of Strike Price
The strike price, also known as the exercise price, is a critical term in the options market. It refers to the set price at which the holder of an option can buy (in the case of a call option) or sell (in the case of a put option) the underlying security or asset. This price is determined at the time the option contract is written and remains constant throughout the life of the option.
Examples
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Call Option Example: If an investor purchases a call option for Company XYZ with a strike price of $50, they have the right, but not the obligation, to buy shares of Company XYZ at $50, regardless of the current market price, until the option expires.
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Put Option Example: Conversely, an investor holding a put option for shares of ABC Corp with a strike price of $25 can sell the shares at $25 even if the market price drops below that during the option’s validity period.
Frequently Asked Questions
What is the strike price in an option?
The strike price is the fixed price at which the owner of an options contract can either buy (call option) or sell (put option) the underlying asset.
How is the strike price determined?
The strike price is set by the options exchange when the contract is initially created and remains unchanged throughout the life of the option.
Can the strike price be adjusted?
In some cases, like corporate actions (e.g., stock splits, dividends), the strike price may be adjusted, but generally, it remains fixed.
What happens when the option’s expiration date is reached?
If the option expires in the money, it can be exercised at the strike price or sold; if it expires out of the money, it becomes worthless.
Why is the strike price important?
It determines whether an options contract will be exercised and affects the profitability of the trading strategy related to that option.
- Call Option: A financial contract giving the buyer the right, but not the obligation, to purchase the underlying asset at the strike price before the option expires.
- Put Option: A financial contract giving the buyer the right, but not the obligation, to sell the underlying asset at the strike price before the option expires.
- Underlying Asset: The financial asset (such as stock, bond, commodity, etc.) which an option or derivative is based upon.
- Expiration Date: The date on which the option contract expires and is no longer valid.
- In the Money (ITM): An option that has intrinsic value, where a call option’s strike price is below, or a put option’s strike price is above, the current market price of the underlying asset.
Online Resources
Suggested Books for Further Studies
- “Options as a Strategic Investment” by Lawrence G. McMillan
- “Understanding Options” by Michael Sincere
- “Options Volatility Trading: Strategies for Profiting from Market Swings” by Adam Warner
Accounting Basics: “Strike Price” Fundamentals Quiz
### What does the strike price in an options contract determine?
- [ ] The price of the underlying asset at the current market.
- [x] The predetermined price at which the underlying asset can be bought or sold.
- [ ] The fee associated with buying an option.
- [ ] The initial deposit required to enter into an option contract.
> **Explanation:** The strike price is the predetermined price at which the holder of an option can buy (call option) or sell (put option) the underlying asset upon exercise.
### In a call option, what action does the strike price allow the holder to take?
- [x] Buy the underlying asset at a set price.
- [ ] Sell the underlying asset at a set price.
- [ ] Hold the underlying asset without purchasing it.
- [ ] Lease the underlying asset.
> **Explanation:** A call option allows the holder the right, but not the obligation, to buy the underlying asset at the strike price before the option expires.
### What happens if a put option's strike price is higher than the current market price of the underlying asset?
- [x] The holder may profit from selling the asset at the higher strike price.
- [ ] The holder cannot sell the asset.
- [ ] The holder incurs a loss.
- [ ] The holder has to buy the asset at the current market price.
> **Explanation:** If a put option's strike price is higher than the current market price, the holder can profit by exercising the option to sell the asset at the higher strike price.
### Can the strike price change once the options contract is in place?
- [ ] Yes, it changes based on market conditions.
- [x] No, it is fixed when the contract is created but might be adjusted for corporate actions.
- [ ] Yes, it can be negotiated between the holder and the writer.
- [ ] No, it never changes under any circumstances.
> **Explanation:** The strike price is generally fixed when the contract is created, though it might be adjusted in cases of corporate actions such as stock splits or extraordinary dividends.
### Which of the following best describes an option that is 'in the money'?
- [ ] The option is no longer valid.
- [x] The option has intrinsic value.
- [ ] It is an option with a strike price far from the current market price.
- [ ] An option that cannot be exercised.
> **Explanation:** An option is 'in the money' when it has intrinsic value; meaning a call option’s strike price is below or a put option’s strike price is above the current market price of the underlying asset.
### Why might an investor choose a higher strike price for a call option?
- [ ] Higher premiums.
- [x] Higher potential leverage.
- [ ] Lower risk.
- [ ] Guaranteed profits.
> **Explanation:** An investor might choose a higher strike price for a call option to achieve higher leverage and maximize potential gains if the underlying asset's price rises significantly.
### What is a buyer's obligation when holding a call option?
- [ ] Must purchase the asset at the current market price.
- [x] There is no obligation to purchase.
- [ ] Must sell the asset at the strike price.
- [ ] Must hold the asset until expiration.
> **Explanation:** A buyer of a call option has the right but not the obligation to purchase the underlying asset at the strike price before expiration.
### Which best defines the function of the expiration date in an options contract?
- [ ] The date when the option can first be exercised.
- [ ] The date the strike price is established.
- [ ] The date range for trading the option.
- [x] The final day the option can be exercised.
> **Explanation:** The expiration date is the final day the option can be exercised by the holder to either buy (call option) or sell (put option) the underlying asset.
### If the market price is below the strike price of a call option, what happens to the option?
- [x] It is out of the money and likely worthless.
- [ ] It is in the money and profitable.
- [ ] It automatically exercises.
- [ ] It converts into a put option.
> **Explanation:** If the market price is below the strike price of a call option, the option is out of the money and is unlikely to be exercised, rendering it likely worthless at expiration.
### What does a higher strike price imply for a put option?
- [ ] Greater loss potential.
- [ ] Less profit potential.
- [x] Higher profit potential if the market price falls.
- [ ] Equal investment risk.
> **Explanation:** A higher strike price for a put option implies greater profit potential if the market price of the asset falls below the strike price, allowing the holder to sell at a higher predetermined level.
Thank you for exploring the depths of options trading with “Strike Price” and challenging yourself with our informative quiz. Keep honing your financial acumen to excel in the world of investments!
