Exercise Price or Strike Price - Explained
What is a Strike Price?
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Table of ContentsWhat is a Strike Price?How a Strike Price WorksExample for Strike PriceAcademic Research on Strike Price
What is a Strike Price?
The price at which a derivative contract can be exercised beneficially is called as Strike Price. Stock and Index Options are usually exercised at Strike Price. It's the price at which a Call Option can be bought at a profit before its expiry, and a Put Option can be sold at a profit before its expiry.
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How a Strike Price Works
Derivative trading, where the traded entity has underlying assets with the actual value, rely on Strike Prices to determine profitable trades. Call and Put Options are the most commonly traded derivative products with underlying assets consisting of equities traded at market value. The value of this derivative is dependent on the fluctuations in price of the underlying assets - which in turn is tied to the Strike Price of the options, as well as the time duration within which the derivative contract can be exercised. Derivative entities yield the maximum profit when traded close to the Strike Price. The most significant aspect of a derivative unit is its Strike Price. Its predetermined based on various factors and written into the contract for the Option. For a profitable trade, an Option must be In The Money (ITM) stage, as close to or at the Strike Price. Strike Prices have standard denominations with fixed dollar amounts like $40, $42, $100, and so on. The value of the option is determined by the difference in the strike price and the price of the underlying stocks. If the Strike Price is higher than the underlying stocks price, the Call Option is Out of Money but a Put Option is In the Money. Fluctuation in the price of the underlying stock will determine the ultimate value of the option as theres a window of time within which the option can be exercised, and any change in the difference in values in the interim can turn the Options profitable.
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Example for Strike Price
Suppose theres an equity thats trading at $3 per share in the market. And there are two Call Options to purchase a unit of Stock Options in this equity, with each Stock Option Unit consisting of 100 equities. One is at the Strike Price of $200 and the other is at $350. The first Option with the Strike Price of $200 is already profitable as it is in the money. Considering that 100 shares of this equity would cost $300 at market value, buying the Option at $200 yields a profit of $100 per unit. This Call Option can be exercised immediately. The second Option has a Strike Price of $350. Let's say the expiration date for this Call Option is 10 market days. At the current Strike Price of $350, the Option is Out of Money as the buyer would incur a loss of $50 if they bought one unit now. The buyer would have to wait out the 10 days period and see if the price of the underlying shares rises to more than $3.5 per share to exercise the option at a profit.