Learn in more detail what a strike price is, how it’s used in trading, and why knowing a strike price is important in options trading.
Definition and Examples of Strike Price
The strike price, or exercise price, of an option is the price of the underlying stock that you would pay to buy or sell the stock if the option was exercised. Options are financial contracts that give the buyer the right, but not obligation, to buy or sell the underlying stock at the strike price during the term of the option. An option giving the right to buy is a call option and an option giving the right to sell is called a put option. Let’s say Netflix (NFLX) shares were trading for $682 per share in 2022, and a trader believed the price would increase over the next four months. So they bought a call option with a $680 strike price trading for $53 per contract. Here’s what that option would be called: NFLX March 22 $680 call $53.00. Note the strike price of $680 is in the option name. The option gives them the right to buy the stock for $680 per share. Because they paid $53 for the option, the stock would need to trade for more than $733 for the trade to be profitable. Let’s say the stock rises to $750 and the trader exercises the option and sells the shares. They buy the shares for $680 and sell for $750 for a $70 per share gain. Subtract the $53 option price and the trader has a $17 per share return.
How the Strike Price Works
Strike prices are generally set in increments of $2.50 between $5 and $25, $5 between $25 and $200, and $10 after that. A strike price is an important part of determining the “moneyness” of the option and the different values that make up the price. Options are considered “in the money” if exercising the option would generate a positive return now (e.g., a call option has a strike price of $50 and an underlying stock price of $55). Options are “at the money” if the strike price is equal to the stock price ($50 for the strike and underlying stock price), and “out of the money” if exercising wouldn’t have a return ($45 underlying stock price and $50 strike price). For in-the-money options, the value that a trader would obtain by exercising the option is called the intrinsic value. In the example above, the intrinsic value is $5, calculated as the $55 underlying stock price minus the $50 strike price. The trader buys the stock at $50 and sells it at $55. In the Netflix example above, the option has a $2 intrinsic value and $51 time value. Part of that high time value is because of the term of the option (four months), and part is because the stock is considered volatile. The strike price is important for calculating tax owed on employee stock options. Employees who receive statutory stock options as part of an incentive option plan don’t pay tax when the option is received or exercised. However, when the stock purchased using the option is sold, the strike price of the option is the cost basis used to calculate taxes owed.
