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 is less expensive than trading stocks.
The strike price of an option is one of the main components when trading options. Despite all the moving parts of 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.
Options Strike Price Introduction
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 for the trader to buy or sell stock. Traders can buy ITM, OTM, and ATM option strikes to fit their needs, and these options are based on the spot price of the underlying market symbol.
If we consider a stock trading at $100.25, an ATM call would be $100.00, an OTM call would be $105.00, and an ITM call would be $95.00. At expiration, a long call would give the option trader the right to buy stock at that strike price, while a long put would give the option trader the right to sell stock at that strike price.
Calls and puts allow traders to purchase or sell stock before the options expire. Option buyers have rights, and option sellers have obligations. Generally, call buyers are bullish on the market since the call option should increase in value as the stock moves higher, while put buyers are bearish on the market since the put option should increase in value as the stock moves lower.
The great thing about put options is that they can act in the place of short selling if you have a broker who isn’t a great shorting broker. This, in turn, allows you to make money in any market.
In the Money
Strike Prices are determined when a contract is written. A strike price tells traders what the price must be to be considered in the money. “In the money” options mean that the call strike is below the market price and the put strike is above the market price.
We say it is “In the Money” because (on the call side) it represents 100 shares of stock that is less than the current stock price, so if a trader were to exercise that call (or “call away” someone’s shares), they could buy the stock “on-sale” from the call seller and then sell that stock on the open market for a profit.
We say that it is “in the money” because (on the put side) it represents 100 shares of stock above the current market price, and so if a trader exercised that put (“put the stock” to someone), then they could sell their shares at a premium greater than the current stock price.
Options Strike Pricing
How many strikes a stock has reflects its liquidity. If there are wide strikes (like 5.00 side strikes or 10.00 wide strikes), this is a sign of either a very costly underlying price (like the SPX Index) or that there are not a lot of option writers and, thus, not a lot of strikes offered. The more liquid a market, the more strikes there are and the narrower the strikes will be.
SPY example: This is the most consistently liquid market ever, with five weekly expirations and 1.00 wide strikes that expand far away from the current share price.
Now – let’s use $CMG as an example – this stock has weekly options but has 5.00 wide strikes, and the strikes do not extend more than a few hundred dollars higher or lower than the current share price.
The bid & the ask are another sign of liquidity. If the spread between the bid & the ask is wide, there is a chance of slippage. Suppose the bid is 21.50 and the ask is 22.50; that would be a 1.00 spread, and we would likely suffer slippage to get into the trade and slippage again later to get out. The more liquid the options are, the smaller the bid-ask spread and the less slippage we must end with.
We can minimize that slippage by using limit orders and avoiding market orders when possible. Try to fill in the bid to buy an option and then ask to sell an option. You would likely have to work that order to fill, but if you work that order $0.01 at a time, you could still fill at a better price than the mid-price.
Importance
What does a strike price tell us? The difference between Strike Prices 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, options trading is a whole different animal from 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. The market will reach $200 by June 7, 2024. Target stock is currently at $160.00 when you’re purchasing the contract, so the $200 strike is currently out of the money.
Then you’d need to look at the bid/ask spread. The bid is $0.14, and the ask is $0.29. If you bought the ask, you’d be paying $0.29 for one options contract. Multiply that by 100, and you’re spending $29.00.
If you were to buy 100 shares of Target at your price of $160, you’d be spending $16,500. As you can see, options are less expensive. However, they do expire, which affects your price and sets a time limit for the trade. However, if you trade shares, you can hold those 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 $0.29 (or $29.00).
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. 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, or 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, they would gain more than out-of-the-money options.
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: Options Strike Price
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.
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.
