What is Strike Price and Strike Price Intervals?
One of the most important aspects of an options contract is the strike price or the exercise price. This is the price at which the buyer agrees to buy the stock and the seller agrees to sell the stock. However, the buyer of the option has a choice so he will only be interested in the option if it is in the money. For example, if A has purchased 2100 strike Reliance call option at Rs.40, then it would be in the money only if the stock price of Reliance is above Rs.2,100. Otherwise, it would be out of money.
In the above illustration, 2100 is the strike price because that is the price at which you strike the deal. Having understood what is the strike price and strike price meaning, let us focus on the aspect of strike price interval. This interval is normally determined based on the price level of the stock. Higher the price level, the higher the interval, and so on. Let us look at strike price options and the strike price interval in greater detail.
Strike Price and Strike Price Intervals
Strike price options are defined as the price at which the holder of options can buy (in the case of a call option) or sell (in the case of a put option). But buy what. This refers to buying the underlying security when the option is exercised. Hence, the strike price is also known as the exercise price. It is called strike price as that is the price at which the deal is struck between the buyer and the seller of the option. It is also called exercise price because that is the price at which the buyer of the option can exercise his / her right to buy in the case of the call option and right to sell in the case of the put option.
Why are strike prices and strike price intervals important. They show the defined prices on which you can have standardized contracts and the strike price interval is a gauge of the risk you carry when you shift to the next interval. Every options trader has to make a selection of option strike price and that is normally a function of premium or price of the option and the moneyness of the option. Now, the moneyness of the option is the extent to which the option is in the money. For example, when the stock price of Tata Steel is Rs.1200, then 1150 call strike has more moneyness than1180 call option. The situation is reversed in the case of the put option. Higher strike put options will have more money than lower strike put options.
What is the relationship between the Strike Price of the call option and the Call Option Price? The basic rule is that the higher the strike price, the cheaper the option. That is because as you go higher in the strike, the option gradually moves from being in-the-money to at-the-money to out-of-the-money. Let us also quickly take a look at the relationship between the Strike Price of a put option and the Put Option Price. The basic rule is that the higher the strike price of the put option, the more expensive will be the option. That is because as you go higher in the strike, the option gradually moves from being out-of-the-money to at-the-money to in-the-money. For example, when Tata steel is quoting in the market at Rs.1100, then the 1180 put option will have more value compared to the 1150 strike put option.
Let us now turn to Strike Price Intervals
Strike Price Intervals are the various levels of strike prices for each Index and Stock option. The exchange authorities determine the strike prices and the strike intervals are also defined from time to time and modified based on the movement in prices. Normally, the strikes close to the actual market price are the most liquid while those far away from the actual price are less liquid.
The rule is that for every Option type, the exchanges provide a minimum of five strike prices during the month. Two contracts will be above the spot price, two below the spot price and the last one will be equivalent at the spot price or an at-the-money contract. Although intervals are fixed, new strike prices keep getting added to existing ones with the movement in spot prices.
What is exercise price
The strike price is also used interchangeably with the exercise price. After all, it is the price at which you strike the contract and also the price at which the buyer of the option can exercise the right to buy or sell depending on whether it is a call option or a put option.
Strike prices for every stock and index option contract are defined by the exchange and they are part of the standardization of exchange-traded derivatives. Picking the strike price is one of two key decisions as it determines the amount of risk you take. The other challenge is picking the right time to expiration, where you decided between near month, mid-month, and far month contracts.
What is the cost of carrying
Let us understand the cost of carrying with a basic commodity futures contract for delivery. To work the contract, there will be the cost of transportation, insurance to prevent the loss, cost of warehousing, and demurrage charges. In the case of the cost of carrying in futures on equity, index futures, or currency futures, there are no insurance, warehousing, or transportation costs as these contracts are cash-settled. Hence, interest cost or national interest is the only factor that goes into the cost of carrying
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Frequently Asked Questions
In call option, the buyer of the call has the right to buy but not obligation. If the price is favourable, the gain becomes the profit of the buyer and the loss of the seller. If the price is unfavourable, the buyer of the option refuses to accept the option and loses the premium. IN that case, the option premium is the full income for the seller of the option.
Normally, the traders trend to stick to the strikes in and around the current price as they are the most liquid and also they fall within your price estimate range. Many of the deep out of the money options may look very low price but that is only because they are just about worth that much. Be cautious about deep OTM and also deep ITM options.
Strike price is based on having 2 ITM options and 2 OTM options apart from 1 ATM option. The strike intervals are based on the price level of the stock.