The concept Strike Price Vs Exercise Price STATES that ‘Strike Price‘ is the price at which the underlying asset can be bought or sold, and ‘Exercise Price‘ the price at which the underlying asset can be bought or sold when the option is exercised.
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What is Strike Price?
The ‘Strike Price’ is the price at which an option can be exercised.
To understand this better, let’s take an example. Suppose you buy a CALL option for Company X with a Strike Price of $50 and an expiration date of six months from now. This means that you have the right to buy Company X’s stock at a price of $50 per share at any time during the next six months.
If the price of Company X’s stock rises above $50 during that time, you can exercise the option and buy the stock at the lower Strike Price. For example, if the stock is trading at $60 per share, you could buy it for $50 per share using your option. You could then sell the stock for a profit, or hold onto it in hopes of FURTHER gains.
What is Exercise Price?
The ‘Exercise Price’ is the price at which the underlying asset can be bought or sold when the option is exercised.
In the example above, the Exercise Price would be $50 per share if you exercised the option and bought Company X’s stock.
It’s worth noting that the Exercise Price is NOT always the same as the Strike Price. In some cases, the exercise price may be HIGHER or LOWER than the strike price, depending on the terms of the option.
Strike Price Vs Exercise Price – Detailed Consideration
In general, the Strike Price and Exercise Price are set BASED on the current Market Price of the underlying asset, as well as other factors such as volatility, time to expiration, and the overall risk associated with the option. Options with LOWER Strike Prices and HIGHER Exercise Prices generally carry more risk, but also have the potential for higher returns.
So why is Strike Price and Exercise Price IMPORTANT? For one thing, they determine the potential profitability of an options trade. A ´CALL´ option with a low strike price can be more valuable than one with a higher strike price, since it gives the buyer the right to buy the underlying asset at a lower price. Similarly, a ´PUT´ option with a high strike price can be more valuable than one with a lower strike price, since it gives the buyer the right to sell the asset at a higher price.
The Strike Price and Exercise Price can CHANGE over time. In some cases, the terms of an option may allow for the strike price to be adjusted if certain conditions are met, such as a change in the underlying asset’s price or the passage of a certain amount of time. This can be beneficial for traders who want to ADJUST their position in response to changing market conditions.
The Bottom Line
Strike Price Vs Exercise Price an IMPORTANT concept to understand when trading options. While they are similar in many ways, they refer to slightly different things and can have a significant impact on the potential profitability of an OPTIONS trade. By taking the time to understand these terms and how they work, traders can make more informed decisions about their options trades and MAXIMIZE their potential profits.
Chartered Accountant (Institute of Chartered Accountants of Pakistan)
Bachelor of Accounting Honours (Asia e University, Malaysia)