In this article, we will discuss
- What Is Options Strike Price?
- How Do Options Strike Prices Work?
- Types of Options Strike Prices
- Example of Options Strike Price
- Factors That Determine Options Strike Price
What Is Options Strike Price?Options contracts are agreements that involve buying or selling underlying securities at a predetermined price on a specific date. This price is called the strike price or exercise price. The options contract gives the holder the right, but not the obligation, to buy or sell the underlying security. Now, options contracts are of two types – call options and put options.
- In case of call options, their strike price will be the value at which traders can buy the underlying assets upon expiry.
- For put options, their strike price will be the value at which individuals can sell the underlying securities on the predetermined date.
How Do Options Strike Prices Work?On stock exchanges, individuals can find options contracts listed at various strike prices which are both above and below their current spot/market price. Let’s say that stocks of a particular company are trading at ₹200/share. So, if traders buy a ₹250 call option for that particular stock, it will give them the right but not the obligation to buy those assets at that price upon expiry. Alternatively, on buying a ₹250 put option, it will give them the right to sell those assets at that particular price on the exercise/expiry date. In case of the call option, if the market price does not exceed ₹250 upon expiry, traders will not exercise their rights, thus letting it expire worthlessly. This is because as these stocks are available at a cheaper price, individuals will incur a loss if they exercise their call. But, if the underlying asset’s value crosses ₹250, traders will exercise their rights, as it will enable them to purchase these securities at a cheaper rate in comparison to their current market value. Alternatively, for the put option, traders will profit if the market value does not cross ₹250. This will enable them to sell the assets at a higher price and book gains. However, if the spot price exceeds ₹250 upon expiration, traders will let the contract expire worthlessly to reduce their losses.
Types of Options Strike PricesAs a derivative options contract nears its expiry date, the underlying asset’s market value or spot price tends to change due to several market factors. Keeping this in mind, strike prices can be divided into three categories:
|Strike Price Higher Than Spot Price||Strike Price Equal To Spot Price||Strike Price Lesser Than Spot Price|
Example of Options Strike PriceLet’s take a look at an example to help you understand how an option can be ITM, OTM or ATM based on the strike price.Suppose, you buy three call options having strike prices of ₹300, ₹345 and ₹350 respectively. Both contracts have ITC stocks as their underlying assets and will expire on the same date. Now, upon expiry, spot prices of these assets reach ₹345/share.
- Under such circumstances, the first contract with a strike price of ₹300 will be in-the-money (ITM). This is because the stocks are trading at ₹345, making the option have a value of ₹45.
- Alternatively, the ₹350 contract is out-of-the-money (OTM) by ₹5. This is because the underlying asset's market value is below the strike price, resulting in a loss.
- Lastly, the ₹345 call option will be at-the-money (ATM). Similar to the ₹350 call, it will not generate any profit. Thus, to minimise losses, the best course of action is to let such contracts expire worthless.
Factors That Determine Options Strike PriceWhen determining option strike price, buyers and sellers should consider several factors. They are as follows:
ConclusionYour proficiency in choosing the right strike price will improve with continuous practice and experience. For new traders, experts advise using a demo trading account to get an idea of what they might face while conducting live trades. Furthermore, choosing a reliable brokerage platform is a must when it comes to successful options trading. In this regard, the New-Gen Samco Mobile App can be an excellent choice. You can open a free demat account with Samco where you can get:
- Lowest margin for trading
- High leverage on 500+ stocks
- Advanced option trading facilities for hassle-free option chain analysis