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. Its 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.
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. Lets 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.
Academic Research on Strike Price
- Study on the Value of Warrant with Variable Strike Price [J], Shi-chang, F. U. (2004). Journal of Yunnan University of Finance and Economics, 5, 006. This paper studies the impact of variable Strike Prices on the value of warrants.
- American lookback option with fixed strike price2-D parabolic variational inequality, Chen, X., Yi, F., & Wang, L. (2011). Journal of Differential Equations, 251(11), 3063-3089. This paper creates a 2-D mathematical model of fixed Strike Price Options traded on the American stock exchanges, to study their behaviour.
- Competitive Bidding Price and Strike Price: Study on the Price Formation Mechanism of the Land Leasing Market [J], DAI, W. P., & GU, H. Y. (2005). Jour. of NW SCI-TECH Uni. of Agri. and Fore, 5, 016. This paper studies the implications of Strike Price and competitive bidding in land leasing markets.
- Conservation law of strike price and inversion of the Black-Scholes formula, Sukhomlin, N. B. (2007). Russian Physics Journal, 50(7), 741-743. This paper explains the inversion of the Black-Scholes formula in light of the conservation law of Strike Price.
- Real Option Similarly American Option With Fluctuated Strike Price, YIN, H. Y., & LI, Z. M. (2006). Journal of Xi'an Institute of Finance and Economics, 4, 007. This paper studies the adaptation of flexible management approach to real options and its implications on capital budgeting.
- Mathematical modelling and analysis of Asian options with stochastic strike price, Calin, O., Chang, D. C., & Alshamary, B. (2012). Applicable Analysis, 91(1), 91-104. This paper evaluates the stochastic average of Strike Prices in Asian markets with the help of a mathematical model and polynomials.
- Pricing Weather Insurance with a Random Strike Price: An Application to the Ontario Ice Wine Harvest, Turvey, C. G., & Weersink, A. (2005). In annual meeting of the American Agricultural Economics Association, Providence, RI. July (pp. 24-27). This paper presents the impact of evaluating Strike Prices in the wine industry for weather insurance pricing.
- An Analysis of the Cross-sectional Impact of Option Trading Volume, Strike Price and Premium of Options on the Volatility of Underlying Stock Prices, Bagchi, D. E. B. A. S. I. S. (2006). The ICFAI Journal of Derivatives Market, 3(4), 19-26. This paper studies the impact of the volatility, trading volume, and Strike Price of Stock Options on the value of the underlying assets.
- Determination about Minimum Level of Reload Option Strike Price [J], LI, C. J., & HE, J. M. (2004). Systems Engineering-Theory Methodology Application, 6, 007. This paper studies the Strike Price fixing process and the implications of fixing the Strike Price value in proximity to the value of the underlying assets.
- The Pricing Formula of the Geometric Average Asian Options with Floating Strike Price in the Continuous Situation [J], Zhao-yuan, L. L. Y. Z. (2008). Natural Science Journal of Hainan University, 2, 006. This paper evaluates the stochastic volatility of floating Strike Prices with data from the Asian Options market.