What is the 'Exercise Price'

The exercise price is the price at which an underlying security can be purchased or sold at when trading a call or put option, respectively. The exercise price is the same as the strike price of an option, which is known when a trade is taken. The difference between the fixed exercise price and the market price of the underlying security at the time the option is exercised is what gives an option its value. 

Breaking Down the 'Exercise Price'

"Exercise price" is a term used in derivatives trading. A derivative is a financial instrument based on an underlying asset. Options are derivatives, with a stock, for example, being the underlying. In options trading, there are calls and puts.

Puts and Calls

A put is the right, but not the obligation, to sell a stock in the future. Investors buy puts if they think the stock is going down or if they own the stock and want to hedge against a possible price decline. They buy puts because it allows them to sell the stock at the strike price of the option, even if the stock falls dramatically.

A call is the right, but not the obligation, to buy a stock in the future. Investors buy calls if they think the stock is going up in the future or if they sold the stock short and want to hedge against a possible surge in price. Calls give them the right to buy at the strike price even if the stock price rallies aggressively.

Typically, investors will only exercise their right to sell their shares at the strike price (put option) if the price of the underlying is below the strike price. Call options are typically only exercised if the price of the underlying is trading above the strike price.

Exercise Price Example

If an investor owns call options for a stock trading at $50 with an exercise price of $45, it means the call options are trading in the money by $5. The exercise price is lower than the price at which the stock is currently trading. The call options give the investor the right to buy the stock at $45 even though it's trading at $50, allowing the investor to make $5 per share by exercising the option. The trader's personal profit would be $5 less the premium or cost they paid for the option.

If the stock is trading at $50, and the strike price of a call option is $55, that option is out of the money. It would not be beneficial for the call buyer to exercise that option because there is no need to pay $55 (using the option) when the trader can currently buy the stock for $50.

The further out of the money an option is the less valuable it is. It only has extrinsic value, or value based on the possibility that the price of the underlying could move through the strike price. The further in the money an option is, the more value it has because it can be exercised giving the trader a better price than what is available in the stock market (or another underlying market).

RELATED TERMS
  1. Call Over

    When the buyer of a call option exercises the option. In options ...
  2. American Option

    An American option is an option that can be exercised anytime ...
  3. Early Exercise

    Early exercise is the process of buying or selling shares under ...
  4. Aggregate Exercise Price

    The strike price of a put or call option multiplied by its contract ...
  5. Exercise

    To put into effect the right specified in a contract. In options ...
  6. Allocation Notice

    An allocation notice, or exercise notice, notifies the option ...
Related Articles
  1. Investing

    Understanding Your Employee Stock Options

    To make the most of employee stock options it's key to understand their risks, tax consequences and how they fit into your financial plan.
  2. Trading

    The Basics of Covered Calls

    Learn how this options strategy can lower the risk of stock or futures contract ownership while increasing potential profits.
  3. Trading

    A Quick Guide To Debt Options

    A look at trading options on debt instruments that include U.S. Treasury bonds and other government securities.
  4. Trading

    Understanding Bull Spread Option Strategies

    Bull spread option strategies, such as a bull call spread strategy, are hedging strategies for traders to take a bullish view while reducing risk.
  5. Taxes

    Tax Treatment For Call & Put Options

    A brief intro to the complex US tax rules governing call and put options with examples of some common scenarios.
  6. Trading

    How to Sell Put Options to Benefit in Any Market

    The sale of a put allows market players to potentially own the underlying security at a future date, at a price below the current market price.
RELATED FAQS
  1. How is a put option exercised?

    Learn the process, and what happens, when you exercise a put option. Also, read about alternatives to exercising an option. Read Answer >>
  2. When holding an option through expiration date, are you automatically paid any profits, ...

    Holding an option through the expiration date without selling does not automatically guarantee you profits, but it might ... Read Answer >>
  3. Can an option be exercised on the expiration date?

    American options can be exercised up to and including the expiration date but European options can only be exercised on the ... Read Answer >>
Hot Definitions
  1. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
  2. Current Assets

    Current assets is a balance sheet account that represents the value of all assets that can reasonably expected to be converted ...
  3. Volatility

    Volatility measures how much the price of a security, derivative, or index fluctuates.
  4. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  5. Cost of Debt

    Cost of debt is the effective rate that a company pays on its current debt as part of its capital structure.
  6. Depreciation

    Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account ...
Trading Center