The strike price, also called the exercise price, is the price written into an option at which the holder has the right to trade the underlying asset. For a call option it is the price at which the holder may buy. For a put option it is the price at which the holder may sell. The strike is fixed when the contract is created and does not change as the market moves.
Together with the underlying asset, the expiry date and the type of option, the strike price defines the contract. The relationship between the strike and the current market price of the underlying determines whether exercising the option would be worthwhile and is the main driver of the option's value.
Strike price and moneyness
Moneyness describes where the strike stands relative to the market price of the underlying.
- In the money. A call whose strike is below the market price, or a put whose strike is above it, could be exercised at a gain. Such a contract is an in-the-money option.
- At the money. The strike is equal or very close to the market price, making the contract an at-the-money option.
- Out of the money. A call whose strike is above the market price, or a put whose strike is below it, would not be exercised. This is an out-of-the-money option.
An option moves between these states as the price of the underlying changes, while the strike stays put.
Intrinsic value and a worked example
The amount by which an option is in the money is its intrinsic value:
- is the current price of the underlying asset.
- is the strike price.
Suppose a share trades at $52. A call with a strike of $50 has an intrinsic value of dollars. If the call's market price, the option premium, is $3.20, the remaining $1.20 is its time value, the amount paid for the chance of further gain before expiry. A call with a strike of $55 on the same share has no intrinsic value, and its whole premium is time value. A put with a strike of $55 has an intrinsic value of dollars. The concepts are covered under intrinsic value and time value.
A buyer who holds the $50 call to expiry breaks even when the share is at the strike plus the premium paid, here dollars.
How strikes are set
For exchange-traded options, the exchange lists a series of strikes at standard intervals around the current price of the underlying, for each expiry date. The interval depends on the price level and on demand: heavily traded shares may have strikes $1 or less apart, while others are spaced at $2.50, $5 or more. New strikes are added as the underlying price moves so that contracts on both sides of the market remain available. For over-the-counter options the two parties agree any strike they wish.
When a company carries out a share split or a similar corporate action, the clearing house adjusts existing contracts so that their economic value is preserved. After a two-for-one split, for example, an option with a strike of $100 typically becomes two options with a strike of $50.
Effect on price and sensitivities
For a given underlying and expiry, a call is worth less the higher its strike, and a put is worth more. The strike also shapes how the option responds to the market. A deep in-the-money call has a delta close to 1 and moves almost one for one with the underlying. A far out-of-the-money call has a delta near zero and responds little until the price approaches the strike. Options with strikes near the market price have the most time value and the greatest sensitivity to volatility and to the passage of time.
Options with different strikes on the same asset do not trade at the same implied volatility. Plotting implied volatility against strike gives a curve known as the volatility smile or, in equity markets, the volatility skew.
Choosing a strike
Selecting a strike is a trade-off between cost and likelihood of payoff. Out-of-the-money options are cheap and offer a large percentage return if the underlying moves far enough, but most expire worthless. In-the-money options cost more and behave more like the underlying itself. Hedgers choose a strike according to the level of loss they are prepared to bear before protection begins, and sellers of options such as a covered call choose it according to the price at which they are willing to part with the asset.
Other uses of the term
The term applies to any instrument with an embedded right to trade at a fixed price. Employee share options have a strike, usually set at the market price on the grant date. Warrants have an exercise price, and a swaption has a strike expressed as a fixed interest rate. For futures options the strike refers to the futures price, and for currency options to an exchange rate.