February 8, 2023

An option strike price is a price at which the subject securities may be purchased or sold once an option has been exercised. The strike price options, sometimes the exercise price, are a significant component of an options contract. It is an important factor of call-and-put options, defining the price at which the option holder can purchase or sell the underlying securities.

What is an Option Strike Price?

The option strike price is a popular term used in the derivatives market, and all investors are familiar with its definition. The strike price can be defined as the future specified price at which an investor will trade the derivative contract on a certain date. There are two types of strike price options: Call and put options. The strike price call option can be defined as the asset’s purchase cost. At the same time, the strike price for put options is the price at which the asset is sold.

Let’s clarify what the term “strike price” means using an illustration.

A Strike Price Example

Let’s say a trader wishes to purchase a call option on a stock now selling at Rs 200 and has a strike price of Rs 185. It implies that the seller thinks the stock price will decline in the future and intends to sell at a strike price of Rs185 to minimise losses.

Another investor, however, conducted a stock study and predicted that the stock price would rise shortly. According to him, the stock price might rise to Rs 250.

Here the strike price chosen by the seller will be the cost at which he will sell the stock at the moment the contract expires.

So, if the market rises and the option stock price reaches Rs 210, the buyer will earn a profit because he purchased the stock at a lower price than what is specified in the contract, which is Rs 185.

Now that you understand what an option strike price is and how it affects options let’s explore the numerous elements that affect strike price.

Factors Affecting Option Strike Price

Risk Tolerance

Risk tolerance is one of the crucial factors you should consider when setting the strike price. Your level of risk tolerance will determine the strike price. The level of risk varies among the various choices. You can choose between ATM, ITM, and OTM types of options contracts depending on your level of risk tolerance. When the option is in the black, the option buyer is pleased, but when it isn’t, everything is fine.

Risk versus Return

This factor is connected with the risk tolerance parameter. You can choose an “In the Money” or “At the Money” contract if you are a risk-averse investor. If an investor has a high-risk tolerance, they can choose an OTM contract.

Volatility

The levels of volatility are variable for each stock option. Numerous variables, including shifts in the economy, modifications to governmental regulations, and other global variables, have an impact on this metric.

Volume/Liquidity

It is another crucial element that influences the striking price. You can estimate the trade’s profitability by looking at the liquidity of the underlying asset. If the asset is more liquid, you can make more money before the contract expiration date. However, lower liquidity doesn’t offer many rewards when you leave the dealership.

Conclusion

The strike price of an option specifies the price at which you can either sell (in the case of a put) or purchase (in the case of a call) the underlying securities before the contract’s expiration. The option strike price plays an important role when you enter into any derivative contract. As a result, you need to grasp the strike price in options and how to calculate it using the many parameters mentioned above.