The concept Strike Price Vs Spot Price STATES that ‘Strike Price‘ is the price at which the underlying asset can be bought or sold, and ‘Spot Price‘ is the current Market Price of an underlying asset. Both terms are frequently used in options and futures trading, and they play a crucial role in determining the profitability of these financial instruments.
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What is Spot Price?
The ‘Spot Price’ is the current Market Price of an underlying asset, such as a stock, commodity, or currency. It is the price at which the asset can be bought or sold for immediate delivery. The spot price is influenced by supply and demand, as well as other factors such as economic and geopolitical events.
In the context of OPTIONS trading, the spot price is the price at which the underlying asset is trading at the time the option is purchased or sold. For example, if you are buying a call option on a stock, the spot price is the current market price of the stock.
What is Strike Price?
The ‘Strike Price’, also known as the ´exercise price´, is the price at which the underlying asset can be bought or sold when exercising an option. In other words, it is the price at which the option holder has the right to buy or sell the underlying asset.
For CALL Options, the strike price is the price at which the holder has the right to buy the underlying asset. For PUT options, the strike price is the price at which the holder has the right to sell the underlying asset. The strike price is determined at the time the option is created, and it remains fixed for the duration of the option contract.
Strike Price Vs Spot Price: The Difference – Context (Option Trading)
The relationship between the Strike Price and Spot Price is critical in determining the profitability of an option. The difference between the strike price and the spot price is known as the option’s intrinsic value. If the spot price is ABOVE the strike price for a ´CALL´ option, the option has intrinsic value, as the option holder can buy the underlying asset at a lower price and then sell it for a profit. Similarly, if the spot price is BELOW the strike price for a ´PUT´ option, the option has intrinsic value, as the option holder can sell the underlying asset at a higher price and then buy it back for a profit.
However, if the spot price is BELOW the strike price for a ´CALL´ option or ABOVE the strike price for a ´PUT´ option, the option has no intrinsic value. In this case, the option is said to be out of the money. This means that the option holder would not exercise the option, as they would be better off buying or selling the underlying asset on the open market.
In addition to Intrinsic Value, options also have Extrinsic Value, which is based on factors such as time decay, volatility, and interest rates. ‘Extrinsic Value‘ is the amount by which the option’s price exceeds its intrinsic value. As an option approaches its expiration date, its extrinsic value decreases as there is less time for the underlying asset to move in the desired direction.
The Bottom Line
The underlying article Strike Price Vs Spot Price STATES that the relationship between the Strike Price and Spot Price determines the Intrinsic Value of the option, which is CRITICAL in determining its profitability. Options traders must take into account both intrinsic and extrinsic value when assessing the potential profitability of an option.
Chartered Accountant (Institute of Chartered Accountants of Pakistan)
Bachelor of Accounting Honours (Asia e University, Malaysia)