Options Strike Prices: How It Works, Definition, and Example

In this article, we will discuss

Options Strike Prices

Options trading can be an excellent strategy for traders who wish to generate high returns within a short time frame. However, to ensure maximum profitability from each trade, selecting the right strike price is essential.

Read on to learn more about options strike price, its types and examples.

What Is Options Strike Price?

Options contracts are agreements that involve buying or selling underlying securities at a predetermined  price on a specific date. This price is called the strike price or exercise price. The options contract gives the holder the right, but not the obligation, to buy or sell the underlying security. 

Now, options contracts are of two types – call options and put options. 

  • In case of call options, their strike price will be the value at which traders can buy the underlying assets upon expiry. 
  • For put options, their strike price will be the value at which individuals can sell the underlying securities on the predetermined date. 

The price difference between an underlying security's market value on the predetermined date and the strike price of the contract determines its intrinsic value. This is also called its “moneyness” and based on this factor, contract holders can incur either a profit or a loss. 

How Do Options Strike Prices Work?

On stock exchanges, individuals can find options contracts listed at various strike prices which are both above and below their current spot/market price. Let’s say that stocks of a particular company are trading at ₹200/share.  

So, if traders buy a ₹250 call option for that particular stock, it will give them the right but not the obligation to buy those assets at that price upon expiry. Alternatively, on buying a ₹250 put option, it will give them the right to sell those assets at that particular price on the exercise/expiry date. 

In case of the call option, if the market price does not exceed ₹250 upon expiry, traders will not exercise their rights, thus letting it expire worthlessly. This is because as these stocks are available at a cheaper price, individuals will incur a loss if they exercise their call.  But, if the underlying asset’s value crosses ₹250, traders will exercise their rights, as it will enable them to purchase these securities at a cheaper rate in comparison to their current market value. 

Alternatively, for the put option, traders will profit if the market value does not cross ₹250. This will enable them to sell the assets at a higher price and book gains. However, if the spot price exceeds ₹250 upon expiration, traders will let the contract expire worthlessly to reduce their losses. 

Types of Options Strike Prices

As a derivative options contract nears its expiry date, the underlying asset’s market value or spot price tends to change due to several market factors. 

Keeping this in mind, strike prices can be divided into three categories:

  • In-the-Money (ITM)

In case traders are holding a call option and the strike price is below its spot price, the contract becomes in-the-money. This will enable traders to purchase the asset at a lower price in comparison to its current market value.  Inversely, if they have a put option, it will be in-the-money only when the strike price is more than the spot price. In this case, individuals will be able to sell the asset at a price which is higher than its current market value.  

  • Out-of-the-Money (OTM)

The options contract will be out-of-the-money if traders are holding a call option and the strike price upon expiry is higher than the underlying asset’s market value.  Similarly, if they have a put option and the strike price is lower than the spot price on the date of expiration, it will be out-of-the-money.  Depending upon whether traders have a call or put option, they will have to buy or sell the underlying at a price greater or lesser than its current market value, resulting in a loss. Thus, there is no point in exercising these contracts. 

  • At-the-Money (ATM)

On the date of expiration, if the strike price is equal to the underlying asset's current market value, it is called at-the-money. Under such circumstances, exercising a call or put option will enable traders to buy or sell the asset at its prevailing market value.  Thus, this transaction will not bring any value and their loss will be equal to the premium amount paid to enter the contract.  Check out the table below for a summarised version of the above-mentioned data:
Strike Price Higher Than Spot Price Strike Price Equal To Spot Price Strike Price Lesser Than Spot Price
Call Option  OTM ATM  ITM
Put Option ITM ATM OTM

Example of Options Strike Price

Let’s take a look at an example to help you understand how an option can be ITM, OTM or ATM based on the strike price.

Suppose, you buy three call options having strike prices of ₹300, ₹345 and ₹350 respectively. Both contracts have ITC stocks as their underlying assets and will expire on the same date. 

Now, upon expiry, spot prices of these assets reach ₹345/share. 

  • Under such circumstances, the first contract with a strike price of ₹300 will be in-the-money (ITM). This is because the stocks are trading at ₹345, making the option have a value of ₹45. 
  • Alternatively, the ₹350 contract is out-of-the-money (OTM) by ₹5. This is because the underlying asset's market value is below the strike price, resulting in a loss. 
  • Lastly, the ₹345 call option will be at-the-money (ATM). Similar to the ₹350 call, it will not generate any profit. Thus, to minimise losses, the best course of action is to let such contracts expire worthless. 

Had these contracts been put options, the scenario would have been a little different. The ₹350 option would have been ITM as you can sell the stocks at a price which is higher than their current market value. Contrarily, the ₹300 put option would have resulted in a loss as you had to sell the underlying assets for less than its stock price.  

Factors That Determine Options Strike Price

When determining option strike price, buyers and sellers should consider several factors. They are as follows:

  • Implied Volatility

Volatility is one of the most prevalent factors in the stock market. Thus, while setting the strike price of options contracts, both buyers and sellers should take into account implied volatility. Doing so helps them mathematically calculate an estimated spot price of the underlying asset upon expiry, along with its probability of being in the money. 

  • Risk-to-Reward Ratio

This is a ratio of the amount of money invested to get the expected return. Traders can conduct technical and fundamental analyses of the underlying asset to calculate various risk-to-reward ratios. Then, based on their risk tolerance levels, they can determine the strike price of the contract. 

  • Liquidity

When determining options strike price, liquidity is also a big determining factor. Usually, contracts with longer expiration periods, lower lot sizes (minimum number of tradable assets) and smaller tick sizes (minimum changes in asset price to be noted by the exchanges) have higher volatility and thus greater liquidity.  

Conclusion

Your proficiency in choosing the right strike price will improve with continuous practice and experience. For new traders, experts advise using a demo trading account to get an idea of what they might face while conducting live trades. 

Furthermore, choosing a reliable brokerage platform is a must when it comes to successful options trading. In this regard, the New-Gen Samco Mobile App can be an excellent choice. 

You can open a free demat account with Samco where you can get:

  • Lowest margin for trading
  • High leverage on 500+ stocks 
  • Advanced option trading facilities for hassle-free option chain analysis

What’s more? On our technology-driven app, you can live stream options premium rates for multiple strike prices from a single screen. Enjoy no restrictions on strike price with Samco and place orders with just a single tap! So what are you waiting for? Join Samco today and start your stock market journey with confidence. Click here to open your free Demat account with Samco now.

Disclaimer: INVESTMENT IN SECURITIES MARKET ARE SUBJECT TO MARKET RISKS, READ ALL THE RELATED DOCUMENTS CAREFULLY BEFORE INVESTING. The asset classes and securities quoted in the film are exemplary and are not recommendatory. SAMCO Securities Limited (Formerly known as Samruddhi Stock Brokers Limited): BSE: 935 | NSE: 12135 | MSEI- 31600 | SEBI Reg. No.: INZ000002535 | AMFI Reg. No. 120121 | Depository Participant: CDSL: IN-DP-CDSL-443-2008 CIN No.: U67120MH2004PLC146183 | SAMCO Commodities Limited (Formerly known as Samruddhi Tradecom India Limited) | MCX- 55190 | SEBI Reg. No.: INZ000013932 Registered Address: Samco Securities Limited, 1004 - A, 10th Floor, Naman Midtown - A Wing, Senapati Bapat Marg, Prabhadevi, Mumbai - 400 013, Maharashtra, India. For any complaints Email - grievances@samco.in Research Analysts -SEBI Reg.No.-INHO0O0005847

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