Strike Price: What it is, how it’s calculated, and how to use it
Imagine you had the option to buy shares in a company at €10 each, even if the market price rose to €15. Would you buy them?
This is the power of the strike price: the pre-defined price at which you can buy or sell an asset in an option. This article will explain what the strike price is, how it is calculated, and why it is a crucial element for investors in call and put options.
What is the Strike Price?
Put simply, in a stock option, the strike price (also called the "exercise price") is an agreed value for buying or selling a share at a future date. It gives investors the right, but not the obligation, to buy or sell an asset at a fixed price by a certain date.
In the case of a call option, this refers to the price at which the asset can be bought. In the case of a put option, this refers to the price at which the asset can be sold.
For example, if the strike price of a call option is €15 and the asset is trading at €18, you could buy the option for €15 and sell it immediately for €18, making a profit of €3.
The strike price is determined using parametric criteria that take into account factors such as the current price of the asset, market volatility, the investor’s objectives, and the time until maturity. It is therefore a fundamental element in the creation of any options position, as it affects both the potential return and the level of risk.
What is the purpose of the Strike Price?
Even without a millionaire’s portfolio or daily market experience, a retail investor can still use the strike price, through financial options contracts, to implement various useful investment strategies, provided they have the necessary knowledge:
1. Protecting the portfolio against losses (hedging)
Imagine that you own shares in a company, but are worried about a potential market downturn. You could purchase a put option with a strike price to act as a kind of "insurance policy”. If the value of the shares falls below this level, the option enables you to sell them at the strike price, thereby limiting your losses.
Example: You own shares in a company worth €15 each. If you buy a put option with a strike price of €14 and the price falls to €12, you can still sell your shares at €14 thanks to the option.
2. Investing with limited risk
With options, you can speculate on the price of a stock going up (with calls) or down (with puts) without actually buying the stock. The maximum loss is the amount paid for the option, also known as the premium (like an insurance policy).
Example: Do you think that a company's share price will rise from €20 to €25? If so, you could buy a call option with a strike price of €21, enabling you to make a profit if the price increases. Otherwise, you would only lose the value of the option.
3. Generate extra income
If you hold shares in your portfolio, you can sell options on them and receive a premium. If the option is exercised, you sell the shares at a fixed price (the strike), which is usually higher than the current market price.
Example: Imagine you own shares worth €10 each and you sell a call option with a strike price of €12. If the share price increases, you can sell your shares for €12 each and make a profit. If not, you get to keep the premium you received for selling the option and the shares. However, it should be noted that selling options without holding the underlying asset is a high-risk strategy and is not recommended.
4. Greater pricing power
The strike price provides a clear point of reference, enabling investors to decide on their desired purchase or sale price for an asset at a future date, and to develop strategies based on this value.
Types of Strike Price
The position of each asset reveals information about the market and the investor. Knowing how to interpret the type of strike is essential for fine-tuning any options strategy.
In the money (ITM)
An option is "in the money” if exercising it would generate a profit. In the case of a call option, this means that the asset’s price is above the strike. In the case of a put option, the strike price is above the market price. Such options have intrinsic value and are more likely to be exercised at a profit.
At the money (ATM)
This means that the strike price is very close to, or the same as, the current price of the asset. It is often used in short-term strategies, where even minor variations can have a significant impact.
Out of the money (OTM)
This occurs when the strike is unfavourable compared to the market price. While these options are more affordable, they are less likely to generate direct profits. They tend to be used in more opportunistic or aggressive strategies.
How to choose the Strike Price
For a retail investor, calculating the strike price essentially involves choosing the appropriate strike price based on the desired outcome of the option:
1. If you want to protect your portfolio (put option):
You can set a strike price below the current price, but still close to the amount at which you are willing to sell. The higher the strike price, the more expensive the option will be, but the greater the protection.
Example: If the share price is €15, you can buy a put option with a strike price of €14. If the share price falls, you can sell the stock at the strike price, thus limiting your loss.
2. If you think the price will rise (call option):
You can set a strike price above the current price. The closer the strike price is to the market value, the higher the probability of making a profit. However, the cost of the option will also be higher.
Example: If the share price is €20, you can buy a call option with a strike price of €21. If the share price rises to €25, you will make a profit. If it doesn’t rise above €21, you will lose the value of the option.
3. If you want to generate income (sell a call on shares that you already own):
You can set a strike price that is higher than the purchase price of the shares. This way, you’re guaranteed to make a profit if the option is exercised, and you will still receive a premium even if it isn’t.
Example: If your shares are worth €10 each, you could sell a call option with a strike price of €12. If the share price does not rise above this, you keep the premium. If the price increases, you can sell at a profit.
How to use Strike Prices when making investment decisions
For investors in options, it is a strategic tool that can directly affect the risk, cost and potential return of each trade. Here are some ways in which you can use it to inform your decision-making:
1. Assessing risk and potential returns
The strike price indicates whether an option is "in the money”, "at the money” or "out of the money”. The greater the difference from the current price, the lower the probability of making a profit, but also the lower the cost.
2. Choosing the most suitable approach for achieving your goal
The type of option (call or put) and the chosen strike price should reflect your desired outcome:
• Protect a portfolio? You can use puts with a strike price close to your "comfort limit”;
• Bet on an increase in value? You can use calls with a realistic strike price that have the potential to increase in value;
• Generate income from shares you already own? You can sell calls with strike prices above the purchase price.
3. Adjust to the time frame and your outlook of the market
The strike should be chosen based on the term of the option and your expectations of the market:
• Do you think the share price will rise too quickly? You can risk a higher strike price;
• Is your only concern to be covered for a few weeks? You can opt for a more conservative strike price close to the current value.
4. Compare costs and benefits
Strike prices that are more advantageous (e.g. much higher in the case of calls) are cheaper, but less likely to generate a profit. Strike prices closer to the current price tend to offer a greater chance of success, but carry higher premiums.
5. Use a specialised analysis platform
With Banco Carregosa’s GoBulling Pro platform, you can follow the progress of options in real time, consult option chains by strike and maturity, and apply strategy-based filters. Thanks to interactive graphs, technical indicators and access to historical data, you can simulate different scenarios and assess their impact before making decisions. This tool is particularly useful for investors seeking greater precision and control over their operations.
Make smart investments with Banco Carregosa
At Banco Carregosa, we provide the knowledge and tools that those looking for more than just a return: control, information and sophistication.
If you want to explore the world of options and master the strike price using a personalised, structured approach, talk to our experts. Our job is to protect and maximise the value of your assets.