Strike Price

Strike Price (also known as the 'Exercise Price'). Think of the strike price as the “deal price” locked into an options contract. It's the fixed price at which the holder of an option can buy (for a call option) or sell (for a put option) the underlying asset, such as a stock, regardless of its current market price. Imagine you have a coupon for a pizza that lets you buy it for $10, even if the menu price goes up to $15. That $10 is your strike price. This price is the anchor of the entire options contract; it doesn't change over the life of the option. The difference between the strike price and the asset's real-time market price is what gives an option its fundamental value. For investors, choosing the right strike price is a crucial strategic decision, balancing the potential for profit against the cost of the option itself. It's the line in the sand where a trade moves from being a potential winner to a real one.

The strike price is the pivot point around which an option's profitability revolves. Its relationship to the stock's current market price determines whether your option has any intrinsic value at a given moment.

How you view the strike price depends entirely on whether you are buying the right to buy or the right to sell.

• For Call Options (The Right to Buy): You hope the stock price soars above the strike price. If you have a call option with a $50 strike price and the stock is trading at $60, your option is “in-the-money” by $10. You can exercise your right to buy at $50 and immediately sell at $60 for a profit (before considering the option's cost).
• For Put Options (The Right to Sell): You hope the stock price plummets below the strike price. If you have a put option with a $50 strike price and the stock is trading at $40, your option is “in-the-money” by $10. You can buy the stock on the market for $40 and exercise your right to sell it at $50.

An option is “at-the-money” if the strike price and market price are the same, and “out-of-the-money” if exercising it would result in a loss (e.g., a $50 call when the stock is at $45).

Let's say shares of Awesome Inc. (ticker: AWE) are currently trading at $100 per share.

1. The Bullish Bet (Call Option): You believe AWE is going to rise. You buy a call option with a strike price of $110 that expires in three months. You pay a premium (the cost of the option), let's say $5 per share. For you to make a profit, AWE's stock price must not only pass the $110 strike price but also cover the $5 premium you paid. Your breakeven point is $115 ($110 strike + $5 premium). Any price above $115 is pure profit before the option expires.
2. The Bearish Bet (Put Option): You think AWE is overvalued and will fall. You buy a put option with a strike price of $90, also expiring in three months, for a premium of $4 per share. To profit, AWE's stock price must fall below the $90 strike price and cover your $4 premium. Your breakeven point is $86 ($90 strike - $4 premium). Any price below $86 is your profit zone.

While often associated with high-speed speculation, options can be powerful tools for the patient value investor. The key is to use them defensively and strategically, not to gamble on wild price swings. For a value investor, the strike price isn't just a bet; it's a carefully chosen price point that aligns with their fundamental analysis of a business.

Imagine you own 100 shares of a wonderful company you bought at $50, and it's now trading at $150. You still believe in the company long-term, but you're worried about a potential market correction. Instead of selling your shares and triggering a tax event, you can buy a put option.

• Strategy: You could buy one put contract (representing 100 shares) with a strike price of, say, $130.
• Outcome: This acts as an insurance policy, a form of hedging. If the stock price tumbles to $100, your right to sell at $130 protects a large portion of your gains. The strike price becomes your safety net. If the stock continues to rise, you simply lose the small premium you paid for the option—a small price for peace of mind.

One of the most popular value investing strategies involving options is selling a cash-secured put. This is a brilliant way to get paid while you wait to buy a stock at a price you already love.

• Strategy: Let's say you've analyzed a company and determined its intrinsic value is around $45 per share, but it's currently trading at $50. You're happy to buy it at $45 or less. You can sell a put option with a strike price of $45.
• Outcome 1: The stock stays above $45. The option expires worthless. You don't get to buy the stock, but you keep the premium you received for selling the option. You essentially got paid for your patience.
• Outcome 2: The stock falls below $45. The option is exercised against you, and you are obligated to buy the 100 shares at the $45 strike price. But that's exactly what you wanted! You've acquired a great company at your pre-determined target price, and your effective cost is even lower because of the premium you collected.