Today's show is focused on answering the most important questions regarding option strike prices. Traders of all experience levels will benefit from this episode because our goal is to supply you with the necessary information to understand this simple, but necessary, options concept.
What is a strike price in options?
The strike price is the price at which you are willing to buy or sell, or you're obligated to buy or sell, the underlying stock. It is the price at which you're going to “strike” a deal with the other party.
An essential component to understand is that the strike price is the price relative to the underlying shares once you get to expiration. The option contract itself can vary a lot in value.
Calculating the strike price
You don't calculate the strike price. Strike prices are set by the exchanges and by the market. They're not flexible and don't move or ebb and flow with the market daily; strike prices go up or down.
As expiration approaches and investor demand increases, new strike prices may become available for certain securities.
Finding an option's strike price
Type in a ticker symbol on your broker platform to access an options chain. You'll have call options on one side, and on the other, you'll have put options. Down the middle will be the strike prices.
Why do some strategies have multiple strike prices?
Some strategies have more than one strike price because they have multiple legs or contracts. The strike prices will correlate to different contracts you're buying and selling.
Strike price vs. break-even price
The simple answer to this question is no. The option strike price is the price at which you're striking a deal with the other party to buy or sell the underlying shares.
The breakeven price factors in the contract's cost and the premium you pay or receive for the contract.
Podcast episode 219 is an in-depth guide to calculating break-even prices for different options strategies.
Choosing the right strike price when trading options
Choosing a strike price is a vital component of trading successfully. Many factors influence what strike price is best for you. It depends on the strategy you're trading, your preference for risk, your timeline, volatility, and current market conditions.
ITM, OTM, & ATM strike prices
Every option has “moneyness” that determines if the contract is in-the-money (ITM), out-of-the money (OTM), or at-the-money (ATM). The strike price relative to the current stock’s price determines the option’s moneyness and greatly impacts the contract’s premium.
When determining if a strike price is in-the-money, out-of-the-money, or at-the-money, the question you’re asking is, "If I were to exercise this option contract immediately, would I make money?" This is known as the contract’s intrinsic value.
Intrinsic value and extrinsic value are two components of an options price.
Why do different tickers have different strike prices?
Not all tickers are priced the same. Therefore they have different strike prices.
The main difference in strike prices between tickers is primarily because of the contract’s value and time frame. Strike prices are typically offered within a range above and below the underlying security’s current price.
Also, if there is more demand for an option, more strike prices will be available.
What happens if the stock hits the strike price?
In the simplest sense, nothing happens. There's no requirement to buy or sell your option contract if the stock hits the strike price.
Touching or challenging, the strike price doesn't do anything new to the option contract and is quite common. The only thing it does is it changes the makeup of the contract’s value.
If you are short an option and the contract is in-the-money, you are at risk of assignment, though that doesn’t typically happen until late in the expiration cycle.
Strike prices and expiration
Options that expire out-of-the-money expire, and the contract is worthless. In-the-money options get assigned or exercised at expiration because they have intrinsic value.
If you don't tell your broker what to do, in many cases, they’ll auto-exercise or auto-assign those contracts if you don't trade out of those contracts before expiration.
Visit the trader’s handbook for more information about options basics.
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