What is a 'Strike Price'
A strike price is the price at which a specific derivative contract can be exercised. The term is mostly used to describe stock and index options in which strike prices are fixed in the contract. For call options, the strike price is where the security can be bought (up to the expiration date); for put options, the strike price is the price at which shares can be sold.
BREAKING DOWN 'Strike Price'
Some financial products derive value from other financial products; they are referred to as derivatives. There are two main types of derivative products: calls and puts. Calls give the holder the right, but not the obligation, to buy a stock in the future at a certain price. Puts give the holder the right, but not the obligation, to sell a stock in the future at a certain price – the strike price – which differentiates one call or put contract from another.
The strike price, also known as the exercise price, is the most important determinant of option value. Strike prices are established when a contract is first written. Most strike prices are in increments of $2.50 and $5. It tells the investor what price the underlying asset must reach before the option is in-the-money.
The difference between the underlying security's current market price and the option's strike price represents the amount of profit per share gained upon the exercise or the sale of the option. When an option is valuable it is referred to as being in-the-money. Worthless options are referred to as being out-of-the-money. Strike prices are one of the key determinants of option pricing, which is the market value of an options contract. Other determinants include the time until expiration, the volatility of the underlying security and prevailing interest rates.
Strike Price Example
For example, assume there are two option contracts. One contract is a call option with a $100 strike price. The other contract is a call option with a $150 strike price. The current price of the underlying stock is $145. Both call options are the same; the only difference is the strike price.
The first contract is worth $45, that is, it is in-the-money by $45. This is because the stock is trading $45 higher than the strike price. The second contract is out-of-the-money by $5. If the price of the underlying asset never reaches the strike price, the option expires worthless. The value of the option is therefore calculated by subtracting the strike price from the current price.