A strike price is the fixed price at which an option holder can buy (call option) or sell (put option) an underlying asset when exercising an options contract. This predetermined price remains constant throughout the option's life and determines whether the option has intrinsic value at expiration.
What is Strike Price
The strike price establishes the reference point for calculating an option's intrinsic value and remains fixed from contract creation until expiration. If you hold a call option with a $50 strike price, you maintain the right to purchase the underlying asset at exactly $50, regardless of current market price.
Key characteristics:
- Set when the option is initially written or granted
- Cannot be changed during the option's lifetime
- Determines the relationship between strike and market price (called moneyness)
- For employee stock options, typically equals fair market value on grant date via 409A valuation requirements
The strike price directly influences the option's premium, time value, and profitability. It serves as the contractual anchor that determines whether exercise becomes economically rational.
How Strike Price Affects Option Value
Call Options and Strike Price
A call option grants the right to purchase the underlying asset at the strike price, becoming valuable when market price exceeds the strike price. Profit = (Market Price - Strike Price) - Premium Paid, with breakeven at Strike Price + Premium Paid.
Real example: You purchase a call option on Tesla stock with a $200 strike price for a $12 premium. At expiration, Tesla trades at $230. Your profit: Intrinsic value ($30) - Premium ($12) = $18 per share (150% return).
| Market Price at Expiration | Intrinsic Value | Profit/Loss |
|---|---|---|
| $90 | $0 | -$12 (lose premium) |
| $105 | $5 | $0 (breakeven) |
| $110 | $10 | +$8 profit |
| $120 | $20 | +$18 profit |
Put Options and Strike Price
A put option grants the right to sell the underlying asset at the strike price, gaining value when market price falls below the strike price. Profit = (Strike Price - Market Price) - Premium Paid, with the strike price creating a floor price for selling.
Protective put example: You own 100 shares trading at $50. You buy a 3-month put with a $48 strike for $2 per share. If stock falls to $40, you exercise the put at $48, limiting loss to $4 per share (versus $10 without protection).
Strike Price vs Spot Price
Understanding the distinction between strike price and spot price is fundamental to evaluating option value and making exercise decisions.
| Characteristic | Strike Price | Spot Price |
|---|---|---|
| Nature | Fixed contractual price | Current market price |
| Changes | Remains constant | Fluctuates continuously |
| Determines | Exercise conditions | Current market value |
| Set By | Option contract terms | Supply and demand |
The spot price represents real-time market valuation, while strike price establishes contractual terms for future transactions. The relationship between these prices determines an option's intrinsic value.
Example: Employee with $25 strike price—Week 1: Spot $20 (OTM by $5), Week 10: Spot $25 (ATM), Week 20: Spot $32 (ITM by $7), Week 30: Spot $40 (ITM by $15). The strike price never changes, but spot price movements alter intrinsic value.
Intrinsic Value: Call Options = MAX(0, Spot - Strike); Put Options = MAX(0, Strike - Spot).
Real-world example: Call option with $100 strike, $110 spot, $14 premium:
- Intrinsic value = $10
- Time value = $4
- Total premium = $14
Moneyness: Understanding Strike Price Position
The relationship between strike and spot price creates three categories: in-the-money (ITM), out-of-the-money (OTM), and at-the-money (ATM).
In-the-Money (ITM): Strike is favorable (Call: Strike < Spot; Put: Strike > Spot). Example: $95 call when stock trades at $100. ITM options are expensive but offer higher probability of profit and lower risk.
Out-of-the-Money (OTM): Strike is unfavorable (Call: Strike > Spot; Put: Strike < Spot). Example: $110 call when stock trades at $100. OTM options are cheap and speculative—70-80% expire worthless.
At-the-Money (ATM): Strike approximately equals current spot price (within 1-2%). ATM options offer maximum time value and balanced exposure with 50% probability of success.
Strike Price Selection for Employees
For employees receiving stock options, the strike price is predetermined at grant, typically set at the fair market value on the grant date.
Key considerations:
- Strike price determines your potential profit per share
- Lower strike prices (earlier grants) offer greater upside
- 409A valuations establish strike prices for private companies
- Tax treatment depends on ISO vs NSO classification
- Understanding vesting schedules is crucial for planning exercise timing
Comparison example:
- Employee A: Granted options at $5 strike (2020), current market price $50
- Employee B: Granted options at $25 strike (2023), current market price $50
Employee A's profit potential: $45 per share Employee B's profit potential: $25 per share
Learn more about how stock options work to understand the full mechanics behind strike price determination.
Practical Examples
Technology Stock Call Option Strategy
An investor believes tech stock TECH will rally. Current conditions:
- TECH spot price: $150
- Time frame: 2 months until earnings
- Budget: $1,500 for options
| Strike Price | Cost per Contract | Breakeven Price | Return if TECH rises to $165 |
|---|---|---|---|
| $140 (ITM) | $15.00 | $155.00 | 67% return |
| $150 (ATM) | $8.00 | $158.00 | 93% return |
| $160 (OTM) | $3.50 | $163.50 | 43% return |
Key insight: The ATM strike generated the highest absolute profit, balancing cost and sensitivity. The ITM strike provided most safety, while OTM offered lowest return despite higher leverage.
Protective Put Strategy
An investor owns 500 shares at $120 and wants downside protection. If stock falls to $95:
| Strike Price | Cost | Protection Level | Max Loss |
|---|---|---|---|
| $120 (ATM) | $3,000 | 100% | $3,000 (5%) |
| $115 (OTM) | $1,750 | First $5 unprotected | $4,250 (7%) |
| $110 (OTM) | $900 | First $10 unprotected | $5,900 (9.8%) |
Higher strike puts provide better protection but cost more. Investors must balance insurance costs against acceptable loss levels.
Frequently Asked Questions
What is strike price in simple terms?
Strike price is the price you agree to pay (call) or receive (put) when exercising an options contract. It's fixed when created and doesn't change throughout the option's life.
How is strike price determined?
For traded options, exchanges set standardized strike prices at intervals around current stock price. For employee stock options, companies set strike at fair market value on grant date, typically determined through 409A valuation.
What happens if strike price exceeds stock price?
If a call option's strike exceeds stock price, the option is out-of-the-money with no intrinsic value. For put options, this creates in-the-money status, allowing profitable exercise.
Can strike price change after grant?
No, strike price remains fixed throughout the option's lifetime. However, corporate actions like stock splits may trigger contractual adjustments to both strike price and shares to maintain equivalent value.
Conclusion
Strike price is the fixed contractual anchor that determines an option's profitability, risk profile, and strategic applications. Understanding strike price positioning—whether in-the-money, at-the-money, or out-of-the-money—enables effective options trading and informed equity compensation decisions. Whether you're using cashless exercise methods to exercise options or evaluating employee grants, strike price selection directly impacts your financial outcome.