Excersise Price: Overview, Put and Calls, In and Out of The Money

Definition

Exercise price, also known as strike price, is the predetermined price at which an investor can buy (Call option) or sell (Put option) an asset in options trading. A call option is “In the Money” if the current market price is higher than the exercise price, and a put option is “In the Money” if the current market price is lower. Conversely, call and put options are “Out of the Money” if the market price is lower and higher, respectively, than the exercise price.

Phonetic

Exercise Price: /ˈɛksərˌsaɪz praɪs/Overview: /ˌoʊvərˈvju/Put and Calls: /pʊt ænd kɔːlz/In and Out of The Money: /ɪn ænd aʊt ʌv ðə ˈmʌni/

Key Takeaways

1. Exercise Price Overview: The exercise price is the predetermined cost at which an underlying asset can be bought or sold during the life of an option contract. It also known as the strike price. The strike price is one of the main determinants of an option’s price and its profitability.
2. Puts and Calls: Put and Call options are the two basic types of options. A Put option gives the holder the right, but not the obligation, to sell an underlying asset at the exercise price, while a Call option gives the holder the right, but not obligation, to buy an asset at the exercise. The value of these options depend on the spot price of the underlying asset as compared to the exercise price.
3. In and Out of the Money: When it comes to options, they are classified as “in the money,” “out of the money” or “at the money.” An option is “in the money” when exercise of the option is profitable (Call option when underlying asset’s price is above exercise price, Put option when underlying asset’s price is below exercise price). Conversely, an option is “out of the money” when exercise of the option would lead to a loss (Call option when underlying asset’s price is below exercise price, Put option when underlying asset’s price is above the exercise price). “At the money” indicates that the spot price and the exercise price are equal, establishing a breakeven point.

Importance

The term “Exercise Price,” also known as strike price, is fundamental in the field of business and finance as it plays a crucial role in options trading. It is the predetermined price at which an options contract can be bought (call option) or sold (put option). Call options are considered “in the money” when the current market price is higher than the exercise price, meaning it’s profitable to buy the asset at the lower strike price and sell it at the market price. On the other hand, put options are “in the money” when the market price is lower than the exercise price, indicating a profit can be made by selling the asset at the higher strike price. Both “in” and “out of the money” options provide investors with strategic opportunities for profit-making and risk hedging, signifying the necessity of understanding the concept and its implications.

Explanation

The exercise price, also known as the strike price, is a key concept in the world of finance and business, particularly in options trading. It refers to the price at which an option holder can buy or sell the underlying asset when exercising the option. The purpose of the exercise price is to provide a reference point for determining the intrinsic value of the option. It allows traders to calculate the potential profit or loss when deciding whether or not to exercise the option. If the market price of the underlying security is favorable compared to the exercise price, the option holder may choose to exercise the option, either buying below market price (call options) or selling above it (put options).In terms of put and call options, an exercise price plays a critical role. For call options, which give the holder the right to buy the underlying asset at a set price, the exercise price is in the money if it’s below the current market price of the underlying asset. The converse is true for put options, which give the holder the right to sell the underlying asset at the exercise price. Here, the exercise price is in the money if it’s above the current market price. The term “out of the money” refers to situations where exercising the option would not be profitable, such as a call option where the exercise price is higher than the market price, or a put option where the exercise price is lower. These concepts guide traders in deciding whether it would be more profitable to exercise the option or let it expire worthless.

Examples

Exercise Price Overview:Example 1: A biotech company ABC Bio has introduced a new drug in the market and investors anticipate that the stock will soar in the next year. An investor purchases an option with an exercise price of $50. If at the expiration the share price is $75, that results in a profit of $25 per share for the investor after exercising the option.Put and Call Options:Example 2: An investor buys a call option for a tech company XYZ Tech at an exercise price of $100, expecting that the company will launch a successful product. If the share price goes beyond $100, the investor can exercise their call option and buy shares at a cheaper rate, then sell them at the market rate for profit.Example 3: A farming company DEF Agriculture is likely to be impacted by pandemic-induced disruptions in the supply chain. An investor buys put options at an exercise price of $30, predicting that the share price will decrease. When it falls to $25, the investor exercises the put option, selling the shares at a higher price than market price, thus creating profit.In and Out of the Money:Example 4: An investor buys a call option for shares of a pharmaceutical company GHI Pharma with an exercise price of $20. If the market price of shares rises to $25, the option is said to be “in the money” as the investor can buy shares at the exercise price and sell them at the market price.Example 5: The investor from the previous example could also experience the opposite situation. If the market price fell to $15, the option would be “out of the money” because the exercise price is higher than the market price. The investor might choose not to exercise the option in this case as they would incur a loss.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Overview: The term “Exercise Price” refers to the price at which an option holder can buy or sell the underlying asset.
• Put and Calls: In finance, a “put” gives the owner the right to sell an asset at a specific price, while a “call” gives the owner the right to purchase an asset at a specific price. The specific price is known as the exercise price.
• In the Money: An option is “in the money” if it would be profitable to exercise. For a call option, this term implies that the market price is higher than the exercise price. For a put option, it indicates that the market price is below the exercise price.
• Out of the Money: An option is “out of the money” if it would not be beneficial to exercise. For a call option, this means that the market price is below the exercise price. For a put option, it suggests that the market price is above the exercise price.
• Option Premium: An option premium is the income earned by the seller of a put or call option. The amount of the premium is influenced by several factors, including the exercise price.

Sources for More Information

• Investopedia – Exercise Price
• The Balance – Puts and Calls
• Fidelity – In The Money
• Options Playbook – Out of The Money