What is a strike price, and why is it important?
When learning about options trading, there are several key factors to consider when learning how to select the best options contract. Choosing the right strike price is the foundation of any good trade. Selecting the appropriate strike price can significantly affect whether or not a trade is profitable.
So what is a strike price?
It’s pretty simple: A strike price is an agreed-upon price at which an options contract can be bought or sold.
When a trader decides what type of options contract they want to buy or sell, they will choose the expiration date and the strike price.
Key Takeaways
- The strike price is the agreed-upon price at which an option can be exercised.
- The strike price is a critical component in determining the value of an options contract.
- The difference in price between the underlying stock price and the strike price determines a stock option’s value. *
- Stock Option Strike Prices
Stock options are derivative contracts that derive their value from the underlying asset. Much like other types of derivative contracts, the stock options strike price is a key variable in determining the value of the contract. The strike price tells a buyer or seller of a contract what price the stock must reach before the option contract is in-the-money (ITM).
The difference in price between the underlying stock price and the strike price determines a stock option’s intrinsic value.
Call Option Strike Prices
A long call strike price determines the price at which a call option buyer can exercise or buy the underlying stock. A short call strike price determines the price at which a call option seller must buy the underlying asset.
Put Option Strike Price
A long put strike price determines the price at which the put option buyer can exercise or sell the underlying stock. A short put strike price determines the price at which a put option seller must buy the underlying stock price.
Strike Price Example
For this example, we will consider two call options on Tesla (TSLA) with the same expiration date. One call option has a $710 strike price, and the second call option has a $750 strike price. The current price of Tesla (TSLA) stock is $745.
At expiration, the $710 call option has $35 worth of intrinsic value because it is in-the-money by $35. The call option with the $750 strike price will expire worthless because it is out of the money by $5.
What Is A Good Strike Price
This depends on the type of trading strategy being used. If a directional trade is being placed using a call or put, we prefer an in-the-money strike price with a delta of 70 and at least a month to expiration. This increases the chances that the trade will be profitable and gives the trade time to work out. Having a delta of .70 means that the options contract will increase in value by 70 cents per share; for every $1 the underlying stock moves in value.
In conclusion
Understanding the basic components of an options contract, such as the strike price, is fundamental to learning to trade profitably. You may consider joining our free trading room if you are new to trading. We cover basic topics regarding options trading and have a robust community of like-minded traders with the same goal: learning to trade profitably.
