Options Strike Price

Strike Price in Options

What is an options strike price, and how do they work? Strike prices make up one of the most fundamental components of an options contract. There are in the money, out of the money, and at the money strikes to choose from. 

Options give you the right but not the obligation to buy (call) or sell (put) a stock at a specified price. One option contract controls 100 shares of a stock. In essence, trading options are less expensive than stocks. 

The strike price of an option is one of the main components when trading options. Despite all the moving parts to options, strike prices are the most important part of an options contract. The strike determines the value. Traders can buy ITM, OTM, and ATM strikes.

The strike price is found in derivatives trading. What are derivatives? They are financial products that derive their value from other financial products. An example of derivatives are calls and puts.

Calls are the bullish option. That means you have the right but not the obligation to buy a stock at a certain price, i.e., strikes. Puts are the bearish option. Hence, it is the right, not the obligation, to sell a stock at a certain price.

The great thing about put options is that they can act in the place of short selling if you have a broker that isn’t a break shorting broker. This, in turn, allows you to make money in any market.

SPs are determined when a contract is written. A strike price tells traders what the price must read to be considered in the money. The money options mean that the call strike is below market price and the put strike is above market price. 

Importance

What does a strike price tell us? The difference between SP’s and the current price of a stock tells us how valuable an options contract is. Options have many moving parts that affect the price of a contract.

There’s time value, implied volatility, and open interest. Not to mention intrinsic and extrinsic value, which make up the strike price. Hence why, options trading is a whole different animal than trading shares. However, you’re not paying as much money for options. If you buy one contract, you’re controlling 100 shares. Let’s take Target, for example. Let’s say that we believe Target will go up to $83.50 by September 7. $83.50 is the strike price when you’re purchasing the contract. It’s currently out of the money.

Then you’d need to look at the bid/ask spread. The bid is $2.06 and the ask is $2.16. If you bought the ask, you’d be paying $2.16 for one options contract. Multiply that by 100, and you’re spending $216.

If you were to buy 100 shares of Target at your price foal of $83.50, you’d be spending $8,350. As you can see, options are less expensive. However, they do expire, which affects your price. You can hold shares until you recover if you make a bad trade.

With options, if you place a bad trade and don’t close out before expiration, you can lose your entire $216. 

Options Strike Price Example

Options Strike Price Example

This is an example of an options chain in ThinkorSwim. The pricing in the center of the picture is the strike price. The current price of the stock is $153.17. At the money, the strike would be $155. In the money is $150. Out of the money is $160. Traders can also look at the options chart.

The options chain is customizable, and columns such as intrinsic value, extrinsic value, and implied volatility can be added—also, Options Greeks such as theta, vega, gamma, and delta.

Options Strike Price Risk/Reward

You want to pick the right strike price for your options trade. That’s a given. That means your risk tolerance and reward are the two most important factors.

What you’re willing to risk determines what kind of option you buy, i.e., in the money, at the money, out of the money. In the money, options are most sensitive to a stock’s price. As a result, if the price increases in the money options, gain more than out or at the money options would.

However, if the price falls, in the money options also lose more than at the money or out of the money options. Although options have more intrinsic value in the money, you can recoup some of the loss if the price fall is moderate.

That’s why you have to pick your risk and reward. Trading risk management is always important. What are you willing to risk? What is your profit target? Plan your trade; trade your plan.

If you don’t have a profit target or a mental stop loss, you have a greater chance of the trade going against you. The risk-reward strategy is an important concept to apply to any trading style.

In the money, contracts tend to be more expensive than out of the money because they’re less risky. If you only have a small amount you’re willing to risk, you may have to go with an out of the money contract.

However, there’s less of a chance for success. Hence, knowing chart patterns, candlesticks, support, and resistance is important.

Final Thoughts

The strike price is a key part of placing an options trade. Picking the wrong strike prices can result in losing the premium you pay. Make sure to practice paper trading them. Although strike prices seem the easiest part of options trading, they’re arguably the most important. 

If you need more help, take our options trading course.

Frequently Asked Questions

Here's an example of an options strike price:

  • $WMT is trading at $157,65
  • The expiration date of Feb 16, 2024
  • ITM strike $150
  • ATM strike $155
  • OTM strike $160

For example, if a trader purchases a call option with a $10 strike price, then they have the right but not the obligation to purchase the stock at $10, even if the price rises above $10.

Traders can sell a call option at any time before the expiration date. If the contract is in the money, they will profit.

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