The strike price of a bought or sold option cannot be changed once that option is traded. Rather, the strike price of the option is predetermined. The only way to change the strike price for a trade is to offset that trade and then buy or sell an option at a different strike price. This can be accomplished by closing the original position, and entering an order for a new position. Specifically, a "Buy or Sell to Close" order and a "Buy or Sell to Open" order. This type of transaction is often referred to as a "roll."
The strike price is the price at which the purchaser of an option can buy or sell the underlying security when it's exercised. For a call option, the purchaser can buy the security at the strike price, while for a put option, the purchaser can sell at that strike price. In order to buy or sell the underlying security, the option must be exercised prior to its expiration date. Options are limited in their duration and expire automatically on that expiration date.
There are two different types of exercise possibilities for options. American options can be exercised at any time up until expiration. European options can only be exercised upon expiration. As a practical matter, American options are usually not exercised early. This is because options have time value associated with them.
Early exercise of an option would negate the benefit of that time value. In fact, most option traders do not exercise their options; rather they offset their trades with a profit or loss. Options trading offers significant leverage for investors by allowing investors to trade larger positions without having to put up the capital to own the underlying security. By exercising the option, the investor then has to use significant additional capital even if he is using a margin account.
Whether an option is exercised or not also depends on the extent to which the option may be in the money. The moneyness of an option refers to the price of the underlying security versus the option’s strike price. An option is in the money if the underlying security is above the strike price for a call option, and below the strike price for a put option. When an option is in the money, it has intrinsic value. The intrinsic value of an option is determined by the difference between the stock price and the option strike.
For example, if the stock of Company XYZ is trading at $50 and an investor owns a call option with a $45 strike price, the option has an intrinsic value of $5. There is a much greater likelihood that an option with intrinsic value will be exercised. In the example, the investor could exercise the option to buy 100 shares at $45 and then sell the shares in the market for a profit of $500.
An out of the money option has less intrinsic value, whereby there is much less likelihood the option will be exercised. In the example, assume that the underlying price of the stock is $40. An investor with a $45 call is not likely to exercise the option since it would not make sense to buy the stock for $45 a share when the market price is $40.
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