What is It and Why Is it Important

Strike prices closer to the current market price typically have higher premiums because they are more likely to end up in the money. Out-of-the-money options have lower premiums but carry a higher risk of expiring worthless. Now suppose a trader recently read the S&P would have a gold-nugget open so decided to buy shares of the S&P exchange-traded fund SPY.

• Here’s how strike prices work, why they matter for options traders and how to understand strike prices.
• Rather, when you would be better off buying shares at the current price of $45.
• Writing covered calls involves selling call options on stocks you already own.
• Because of this, the further out-of-the-money you go, the cheaper the option becomes.
• An option’s value at expiration is determined by whether or not the underlying stock’s price has crossed that line and by how much.

The option would lose value if the stock falls in value as the underlying stock increases in price. For call options, the strike price represents the price at which the underlying security can be bought, while for put options, it is the price at which the security can be sold. The value of an option is greatly influenced by the difference between its strike price and the current market price of the underlying security. Traders should consider various scenarios they could encounter with each option contract they enter, and they should always have a plan B.

The overall state of the market greatly impacts strike price selection. In a highly volatile market, traders often choose strike prices further away from the current market price. This is because greater volatility increases the likelihood of large price swings, making out-of-the-money options more attractive due to their lower initial cost and higher profit potential. Many new traders gravitate toward out-of-the-money options because they’re cheaper, but they often overlook the low probability of these options becoming profitable. For example, buying a call option with a $100 strike price on a stock currently trading at $80 might seem affordable, but it’s a risky bet unless you expect significant upward movement.

• For example, if you buy a call option with a $50 strike price and the market price only goes up to $49, you can’t exercise the option profitably.
• Out-of-the-money options have lower premiums but carry a higher risk of expiring worthless.
• They define the price at which you can buy or sell the underlying asset and influence the option’s premium, profitability, and risk level.
• But understanding the relationship between the strike price and the underlying’s current trading price helps, especially when the market shivers because inflation is coming.

Strike Prices & Option Moneyness

Strike price and exercise price mean the same thing—they are both the price you’ll pay to buy (call) or sell (put) the underlying asset if you choose to exercise the option. For long options, as long as it hasn’t expired, nothing happens automatically. However, short positions risk being assigned if they move past at-the-money and become in-the-money. Some traders will use one term over the other and may use the terms interchangeably but their meanings are the same. An option with a delta of 1.00 is so deep in-the-money that it essentially behaves like the stock itself. Examples would be call options very far below the current price and puts with strikes very high above it.

Example: 2-Point Vertical Call Spread

In-the-money options present profit opportunities, but investors can only make money if the amount made on the trade is more than the premium paid on the initial purchase. A good example of making money with an in-the-money option is an option that’s trading for $40 with a strike price of $30. ATM options are popular with traders or investors who are looking for short-term price movements—they can play a considerable role in trading strategies like strangles and straddles. The underlying asset price would have to shift even more so than an at-the-money option for the purchase to be turned around into a profitable trade.

Why do strike prices matter?

The market price is the asset’s current value in the market, which fluctuates constantly. The difference between these prices determines whether the option is in the money, at the money, or out of the money. For instance, if you’re using options to hedge against potential losses, choosing a far out-of-the-money strike price won’t offer adequate protection. Similarly, speculative traders aiming for high returns might miss out by choosing a strike price that’s too conservative.

Risk-reward analysis

The higher that probability, the greater the value of the right that the option grants. Finally, don’t think that you make money only when an option is in the money. Many low-risk options strategies revolve around selling options that will eventually be out of the money. The best option brokers offer tools that help investors spot opportunities in options and can show graphically the payoffs and break-even points. For example, using the December 2024 $45 call option from before, the option would be worth $5 per contract if the underlying stock finished expiration in December at $50, or $50 minus $45. If the stock finished below $45, however, the call option would be worthless.

Understanding the underlying asset helps traders assess how likely (or unlikely) an option’s strike price will be reached, which impacts an option’s profit or loss scenarios. Conversely, out-of-the-money (OTM) options, which have strike prices above the market for calls or below for puts, do not hold intrinsic value but carry extrinsic or time value. For a put option, the option becomes more valuable as the stock price falls below the strike price. However, the put option expires worthless if the stock price is above the strike price at expiration.

In practice, there are usually standard strike price intervals for securities that have active options markets. Generally, 2 1/2 points when the strike price is between $5 and $25, 5 points when the strike price is between $25 and $200, and 10 points when the strike price is over $200. However, these intervals can and will vary based on a number of factors. Believing that Company A will deliver a strong quarter, you decide to purchase a call option. This contract gives you the right, but not the obligation, to buy 100 shares of Company A at a price of $50 before a specific date.

The offers that appear on this site are from companies that compensate us. But this compensation does not influence the information we publish, or the reviews that you see on this site. We do not include the universe of companies or financial offers that may be available to you.

The spot price is another term used for the current market price of the underlying security. Pricing models such as the Black-Scholes Model and the Binomial Tree Model were developed in the 1970s and ’80s to help understand the fair value of an options contract. Theoretically, an option’s premium should be related to the probability that it finishes in-the-money.

Do strike prices matter if I don’t want to exercise an option?

If a stock is trading at $100 and you expect it to drop to $90, choosing a $95 strike price balances cost with profitability. If you expect a stock to rise, you might choose a strike price slightly above the current market price. For instance, if a stock is trading at $50 and you anticipate a price increase to $60, you could select a $55 strike price. This keeps the option affordable while allowing for significant profit if your prediction is correct. If you prefer safer bets, you might choose in-the-money options with higher premiums but better odds of profitability. For instance, selecting a call option strike price just below the current market price offers a high likelihood of gains if the asset continues to rise.

You may have strikes that result in $0.50 or tighter due to stock splits or other events. Take your business to the next level with seamless global payments, local IBAN accounts, FX services, and more. A copay is a standard out-of-pocket amount that an insured individual has to pay each time they get medical care.

Out-of-the-money options are cheaper to buy but have a lower chance of profit, while in-the-money options cost more but have higher intrinsic value. Strike prices are crucial when trading spreads because they determine both your risk and profit potential. The difference between the strike price and the spot price determines an option’s moneyness and greatly informs its value. The strikes will generally be wider for stocks with higher prices and with less liquidity or trading activity.

If Company A’s stock closed exactly at $50 on expiration day, the $50 call option would technically be “out-of-the-money” stock market crashes and expire worthless. At any point in time, an options contract will be in one of three “money” states. Moneyness is determined by the relationship between the stock price and the option’s strike price. The option is out-of-the-money (OTM) for buyers of the call option if the strike price is higher than the underlying stock price.