What is the Strike Price?
The strike price or also known as the exercise price, is the price to which a holder of a call option has the right but not the obligation to purchase the underlying stock at the strike price, up to the expiration date if exercised. A put option buyer, has the right to sell the underlying stock at the strike price up to the expiration date if exercised.
What happens when an option hits the strike price?
When you buy a put option, the strike price is the price at which you can sell the underlying asset. This is generally used as insurance.
Example: You currently own 100 shares of Under Armour and had bought them at 32. You would then buy a PUT Option at the 32 strike price. If the price of the stock drops less than 32, you can then exercise the put option that you had bought, and can still sell your shares at the price of 32 instead of what the stock has dropped to.
When you buy a call option, the strike price is the price at which you can purchase the underlying asset, or stock.
Example: You buy an option for Under Armour at the 32 strike price, and the current price of Under Armour is 32. If Under Armour rises to $40 at or before expiration, you can exercise the option for $32, and would be assigned 100 shares for $32 each. The total cost is $3,200 plus the bought call contract. You could then turn around and sell the shares for $40 each or the full 100 shares for $4,000 for a profit of $800 minus the purchased call option that you originally purchased. Remember 1 option contract is 100 shares.
As you can see, this is when an option hits the strike price depending on if it is a call or put option. Call option buyers have the right but not the obligation to purchase the underlying asset, while put buyers have the right but not the obligation to sell the underlying asset.
What happens if the strike price is not hit?
If the strike price is not hit, then the value of the option contract expires worthless. Sometimes the contract is still worth pennies, but overall worthless or less than you originally had purchased it for. If you are selling premium, then you would have to buy back the contract for more than you originally sold it for.
Options can be exercised or not exercised and just sold and bought for higher or lower prices as well. The exchange of options contracts is also a strategy that most investors and traders use as well.
It’s also important to note, that the farther away from the strike price, the value of the options become less. This is due to the market based off of risk to reward. The statistics are applied, and the farther away from a strike price an option is the less likely it is to hit that price.
How to choose the right strike price for options?
While there is no correct way when choosing the right strike price when selling or buying options, it is often associated with your risk tolerance. Each investor or trader has a a different strategy when choosing the correct strike price depending on their investment tolerance, size of portfolio, end investment goals, and the nature of of the strategy itself.
There are also factors that include that the majority of the professionals use, and that is RSI, MACD, Implied Volatility, IV Rank, and other various strategies, indicators and statistics.
I would highly recommend picking up copies of my Treat Your Stocks Like Real Estate and How to Create Cash Flow Without Owning Stock. I cover the advanced techniques that I have used over the years to pick the best strike prices and more in the eBooks.