What is the strike price in options trading?
The strike price in options trading is the price at which an options contract can be exercised. Picking the correct strike price is one of the two most important decisions you’ll make when trading options – the other is choosing the right expiry date.
Learn more about how to trade options
The strike price is the price that you agree to either buy or sell an underlying asset for in an options contract. Before we explain the strike price in options trading further, you need to understand the concept of rights and obligations when buying or selling call or put options:
- When you buy a call option, you have the right to buy an underlying market at the strike price before a set expiry. For this right, you’ll pay a premium
- When you sell a call option, you have the obligation to sell an underlying market at the strike price before a set expiry. For taking on this obligation, you’ll receive a premium
- When you buy a put option, you have the right to sell an underlying market at the strike price before a set expiry. For this right, you’ll pay a premium
- When you sell a put option, you have the obligation to buy an underlying market at the strike price before a set expiry. For taking on this obligation, you’ll receive a premium
How does the strike price work when trading options?
When trading options, the underlying market price must move through the strike price to make it possible for that option to be executed – known as in the money. If this doesn’t happen, the option will expire worthless – known as out of the money.
Call options with higher strike prices are usually less expensive than those with lower strike prices because it’ll take a bigger price move in the underlying market for them to be at the money. This is the third possibility for an option’s current price, and at the money means that the option has an equal or incredibly similar chance of expiring either with or without a value.
But, when trading put options, this is reversed. So, put options with low strike prices will be more expensive than put options with higher strike prices.
It’s also worth bearing in mind that strike prices are set at predetermined levels. That means that while you have the autonomy to pick a strike price, you cannot directly set that strike price yourself.
Strike price example
Let’s go through an example of an option trade to show you what the strike price means. Suppose you buy an AAPL 120 call with the stock trading at 120. This would be an at-the-money option, capable of expiring either in profit or worthless. For this example, the share price rises to 125 – pushing the option to in-the-money status because the underlying price has surpassed the strike price of the contract.
But, let’s say that instead of rising to 125, the underlying market price had actually fallen to 115. This would mean that the option would expire worthless because the underlying market price has not exceeded the strike price of the call option. You’d lose your premium in this case, but nothing else.