This blog explains what strike price means and how it works in options trading. It covers the relationship between strike price and moneyness, explains ITM, ATM, and OTM options, and shows how factors such as premium, expiry, and market outlook influence strike-price selection.
Quick Overview
- Strike price is the predetermined price at which an option holder can buy or sell the underlying asset.
- The relationship between strike price and market price determines whether an option is ITM, ATM, or OTM, while the premium affects the buyer’s actual profit or loss.
- Strike-price selection depends on factors such as market outlook, expected price movement, expiry, premium, liquidity, and risk tolerance.
If you’re exploring options trading for the first time, you’ve probably come across terms like strike price, premium, expiry, ITM, ATM, and OTM. Among these, the strike price is one of the first concepts you need to understand because it forms the reference point of any option contract.
But what exactly does it mean, how does it affect an option contract’s value, and how do traders decide which strike price to choose?
This guide breaks down the role of strike price in options, explains its relationship with moneyness, and shows how to evaluate different strike prices using simple examples.
What is Strike Price in Options?
A strike price, also called an exercise price, is the predetermined price specified in an options contract at which the option holder has the right, but not the obligation, to buy or sell the underlying asset. For a call option, it is the price at which the holder can buy the underlying asset; for a put option, it is the price at which the holder can sell it, subject to the contract’s terms and expiry.
By comparing the strike price with the underlying asset’s current market price, you can determine whether an option is in-the-money, at-the-money or out-of-the-money. The strike price mainly determines an option’s intrinsic value, while factors such as time to expiry and market volatility also influence the option’s premium.
How Does Strike Price Work?
Before understanding how strike price in an option works, it helps to know what option moneyness means. Moneyness describes the relationship between an option’s strike price and the current market price of the underlying asset. It indicates whether the option is in-the-money, at-the-money, or out-of-the-money.
Since the strike price is fixed, an option’s moneyness depends on how it compares with the underlying asset’s current market price and whether it’s a call or a put. The option premium does not determine moneyness, but it does affect your overall profit or loss. Let’s look at an example.
Understanding Strike Price with Examples
Let’s see how different strike prices affect an option’s position and, ultimately, its profit or loss.
For example, assume a stock is trading at ₹1,000:
- Call option: A ₹950 strike is ITM, ₹1,000 is ATM, and ₹1,050 is OTM.
- Put option: A ₹1,050 strike is ITM, ₹1,000 is ATM, and ₹950 is OTM.
Here’s what each position means and how it relates to profit or loss:
- In-the-money (ITM): The option has intrinsic value because exercising it would be favorable compared with the current market price. However, the buyer makes an actual profit only when this intrinsic value exceeds the premium paid.
- At-the-money (ATM): The strike price is approximately equal to the current market price, so the option has no intrinsic value. The buyer does not recover the premium through intrinsic value alone, so the position remains dependent on how the option contract’s value changes before expiry.
- Out-of-the-money (OTM): The option has no intrinsic value because exercising it would currently be less favorable than trading at the market price. If it remains OTM at expiry, the option expires worthless and the buyer loses the premium paid.
This makes the distinction much clearer: ITM, ATM and OTM describe an option’s position relative to the market price, while the premium determines how that position translates into the buyer’s actual profit or loss.
How to Choose Strike Price for Options?
Choosing a strike price starts with your market outlook, expected price movement in the underlying asset, risk appetite, and the time left for option expiry. You also need to consider whether you are choosing a weekly or monthly expiry, as the time available for the expected move differs.
Take ABC Ltd., trading at ₹1,000, as an example. Suppose you expect the stock to rise:
- ATM Call (₹1,000): When you expect a moderate upward move and want a strike close to the current market price.
- ITM Call (₹950): When you have stronger conviction in the upside and prefer a strike that already has intrinsic value.
- OTM Call (₹1,050): When you expect a larger upward move and are willing to choose a strike further from the current price.
For a bearish outlook, the same logic applies to put options, but in reverse: an ITM put has a strike above the current stock price, while an OTM put has a strike below it.
Weekly vs monthly expiry
Expiry choices depend on what you trade. In India, stock options expire monthly only. Weekly expiries exist only on one benchmark index per exchange (Nifty 50 on NSE, Sensex on BSE).
When you choose an expiry, consider how soon you expect the underlying asset to make the anticipated move. For example, if you expect the underlying asset to move in your favor within a few days, a weekly expiry may align more closely with your trading view. If you expect the move to take several weeks, a monthly expiry gives the position more time to play out. However, you should note that options lose time value as they approach expiry, so a longer expiry also comes with a different premium and risk profile.
Your decision should therefore consider the available strike prices, option premium, liquidity, time to expiry and your risk tolerance. Both NSE and BSE provide multiple strike prices for eligible F&O stocks, allowing you to select a contract that aligns with your market view and expected timeframe.
Conclusion
Choosing a strike price is not simply about selecting the one closest to the underlying asset’s current market price. The appropriate strike depends on your objective, market outlook, and the risk you are willing to take. Your choice should therefore reflect your expected price movement, risk appetite, and time to expiry.
Your objective matters because options can be used in different ways. You may use them to hedge an existing investment or to take a position based on an expected price movement. However, options are complex instruments, and their premiums can change significantly as market conditions and expiry timelines change.
