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Friday, February 23, 2024

Strike price vs. exercise price: What’s the difference?

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In options trading, the strike price and exercise price are synonymous terms denoting the price at which you have the right to buy or sell an underlying security. They both represent the price established when the option was acquired, and investors commonly use these terms interchangeably. However, it is important to note that a single security can have multiple options with varying strike (exercise) prices.

What does the strike price or exercise price mean?

To answer that, let’s first delve into the concept of options. Simply put, an option grants you the right, though not the obligation, to buy or sell a security (such as a stock or other asset) at a predetermined price within a specified timeframe. Investors utilize options to potentially amplify their gains or hedge against risk. However, it’s crucial to note that if options are not exercised before the expiration date, they lose all value.

When trading options, the strike or exercise price represents the price at which you can buy or sell the underlying security. This process is known as exercising your options. Traders commonly use both terms, strike price and exercise price, to refer to the same concept: the specific price outlined in your options contract.

There are two primary types of options: call options and put options. To be considered “in the money” or profitable with a call option, the price of the underlying asset must exceed the strike price prior to the option’s expiration. Conversely, a put option is deemed “in the money” when the stock price falls below the exercise price.

Keep in mind: the strike price differs from the price you pay for the option contract itself, which is referred to as the premium. For example, an option contract could have a $1 per share premium and a strike price of $50. If you purchase the option for 100 shares (which is the typical amount in an options contract), you would pay $100. When calculating your potential gains, make sure to subtract the cost of the premium.

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