The option strike price is the fixed price at which the underlying security or asset can be purchased or sold on or before the contract’s expiration date. The option strike price can also be called the exercise price on the expiration date.
What is the Strike Price?
The option strike price plays a crucial role in computing an option’s moneyness and is required to determine all options positions’ break-even points and profit or loss.
The moneyness of options, whether called or put, is based on the difference between the underlying and strike price because the price of the asset or underlying (spot price) fluctuates. In contrast, the strike price is fixed for the duration of the option contract.
How to Calculate Option Strike Price?
Each security listed for derivatives trading has its strike prices calculated and announced by the exchange. As is well-known, trading in derivatives includes securities with a higher open float that are actively traded. You must meet predetermined exchange criteria for a security to be eligible for options trading, some of which include risk tolerance, volatility, and standard deviation of daily price change. The stock exchange also considers the total contract value as a qualification factor in calculating the option stock price.
Several pricing algorithms use these factors to calculate the option’s fair market value. The Black-Scholes model is the most well-known of them. Options are similar to other investments in many respects; to use them properly, you must comprehend what influences their pricing. Other models, such as the binomial and trinomial, are also frequently employed.
Let’s begin by discussing the four main factors that affect an option’s pricing: volatility, time value or time to expiration, intrinsic value, and current stock price. The current stock price is rather simple. Generally, the price of the option is directly influenced by changes in the option’s stock price. As the prices of the stock increase, the prices of the call option tend to increase, and the prices of the put option are most likely to decrease.
Let’s use an illustration better to grasp the computation of the option strike price.
Assume the Nifty50 spot is now trading at 16,200. In this case, the 16,200 call option strike on the Nifty50 will be referred to as an “at the money” (ATM) option. The strike price of the 16,300 call option will also be considered “out of the money” (OTM). And the “in the money” (ITM) option will have a strike price of 16,100.
The 16,200 strike price for put options will also be referred to as “at the Money” if the Nifty50 trades at that price (ATM). “Out of the Money” (OTM) will be used to describe the 16,100 strike price, while “in the Money” will be used to describe the 16,300 strike price (ITM).
The strike price is a cutoff point for calculating an option’s intrinsic value. Option strike prices that are “in-the-money” or ITM will always have a positive intrinsic value. There will be no inherent value for “at-the-Money” or ATM strikes and “out-of-the-Money” or OTM strikes.
The related price (LTP) to the call and put option reflects the moneyness of the strikes, as shown in the table above.
When the price of the security for a call option is higher than the strike price, the option is called “in the money.” All the high-in-the-money strikes are premium and have a higher intrinsic value, as seen in the table above.
Similar to call options, a put option is called “in the money” if the price of the security is higher than the strike price (Nifty50 Spot > Nifty50 Strike).
Conclusion
For an options investor or trader, choosing the option strike price is crucial because it has a major contribution to the earnings of an option position. You must research to get the best strike price to increase your chances of success in options trading.