Introduction
Options trading is a popular invest method. An option is a financial derivative which gives the buyer the choice to buy or sell an underlying asset at a predetermined price, called the strike price.
In this article, we will take a closer look at what happens when an option reaches its strike price.
Definition of a Strike Price
A strike price is the cost at which a person with an option, such as a call or put, can buy or sell the underlying asset. It is also known as the exercise price or offering price.
When an option reaches its strike price, it means the underlying asset has reached the same level as the strike price by the expiration date. This does not mean buyers will exercise their options straight away – this just means they can if they choose.
Depending on whether it’s a call or put option and if it’s in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM), there are various outcomes when it reaches its strike price:
- For ITM calls, holders can exercise their rights to buy shares of the underlying stock at the lower cost of their purchase, rather than the current market prices. But, OTM calls don’t offer any benefits upon exercising since no discount is offered on stock prices when they go in-the-money before expiration day.
- For ITM puts, holders may receive cash equal to their buy premium plus what remains after subtracting current market prices from the purchase cost of their options contract. On the other hand, OTM puts won’t give any benefit upon exercise since current market values are higher than the purchase cost.
What Happens When the Stock Price Hits the Strike Price?
When a security’s stock price reaches an option’s strike price, it is said to have “hit the strike”. This has many consequences for option holders. Do they have the power to buy or sell the asset at the strike price? Let’s take a closer look at what happens when an option hits the strike:
In-the-Money Options
In-the-Money (ITM) options have intrinsic value. This means at expiration, holders of these contracts can make a profit by exercising them. This happens when the strike price is lower than the asset’s current market value.
For example, if an ITM call option with a strike price of $20 has a current market value of $25, exercising it will guarantee a profit of $5. If 10 contracts are held, $500 will be added to the account ($50 x 10).
The same applies to ITM put options. If the strike price is $30 and the current market value is $25, there will be a $5 profit when exercising the contract. Although this may not cover any losses before reaching its strike price, profits can still be made.
In conclusion, when an in-the-money option hits its strike price, any profits from executing are realized immediately. Any remaining losses up to that point are not registered until expiration. These would become apparent if no further actions are taken.
Out-of-the-Money Options
An out-of-the-money option is when the stock price or underlying asset is lower than the strike price. This option has zero intrinsic value, but it can gain profits through time decay or volatility changes.
- For a call option, if the strike price is higher than the market price, it will stay out-of-the money.
- A put option will remain out-of-the money if its strike price is lower than the market price.
Out-of-the money options are still useful. They provide unlimited potential in a rising market and low risk with no upfront cost. This makes them great for hedging and getting into trades with little risk and big upside. If an option moves in-the-money, its gains will decrease and risk will go up.
Before expiration date, investors should manage open positions to get some exit strategies and capture profits without losing cost basis on certain deals.
Expiration of Options
Options have a limited lifespan. At the end of that period, they expire. If the option holder chooses to use it, they can do so at the pre-decided strike price. If they don’t, the option will become worthless when it expires.
This article will discuss what happens when the strike price is hit and the option expires:
American-Style Options
American-style options can be used or sold any time before they expire. When exercised, the holder must give the issuer cash or the underlying asset, like a stock.
It’s tricky to keep the option long until expiration, as someone else could exercise it first. If you have an American-style call and don’t want it exercised early, place a limit order and watch for large trades, which may indicate someone else exercising their option.
In contrast, European-style options only expire on the listed date. When buying/selling it, make sure you know when it expires, so you can adjust your strategy in time.
European-Style Options
European-style options are a type of option contract that can only be used during a particular period, usually at expiration. Unlike American-style options, which can be used before expiration, these options cannot. This difference could confuse option traders.
When an option is European-style, if it hits its strike price at expiration, it will no longer exist. On the third Saturday of the listed contract month, it will expire without worth or intrinsic value. So, if you buy a European-style option with a strike price that has been hit before expiration, you’ve wasted your money.
On the other hand, if a deep in the money call option hits the strike price on the third Saturday of expiration, it may still have value. This is if there is time left to trade until 4pm EST when US markets close. If this happens, the deep in the money call may be exercised for its intrinsic value. This is as long as it can reach settlement date after 4pm EST.
Implications for Investors
Options striking the price means something for investors. A call or put option’s strike price is essential to how investors react and its impact on their investments. This article will discuss what happens when an option hits the strike price.
Benefits of In-the-Money Options
ITM options can offer investors various advantages. These include an increased chance of cashing in on the time value premium, greater control over the investment’s result, and the potential to make a lot if the underlying asset’s price rises or falls significantly.
An ITM option is one with a strike price lower than the stock or futures index’s present market price. For instance, if an investor owns a call option with a strike price of $60 for XYZ stock that trades at $90 per share, the option is ITM since it has intrinsic value of $30 (90 – 60 = 30). If the share price climbs to $110, the intrinsic value is $50 (110 – 60 =50). This implies that if the Holder opts to exercise this call Option, they will immediately gain a profit of $20 per contract (50 – 30 =20).
ITM options are especially advantageous when a large move is anticipated in either direction. Your returns will be greatest as you benefit from both time and/or intrinsic value appreciation plus any move in the underlying asset beyond your strike price. This is especially attractive when trading options on volatile underlying indexes such as SPX and VIX, as these instruments have wide swings which can bring attractive returns over brief periods. Furthermore, investors who use multiple positions to leverage their money will usually find they can lower their risk while still capturing big moves through their ITM positions.
Risks of Out-of-the-Money Options
Out-of-the-Money Options (OTMs) have a lower strike price than the underlying stock. These are riskier investments than In-the-Money (ITM) and At-The Money (ATM) options. OTM options are cheaper, making them attractive to investors. But, there are risks.
- First, OTM options have higher volatility than ITM/ATM options. This means too much fluctuation can occur before expiration.
- Second, OTM options have wide bid/ask spreads. This leads to less liquidity when attempting to close out of positions.
- Finally, OTM option prices change rapidly near expiration. This makes it hard for individual investors to judge value. Losses can occur if not managed correctly.
Investors should understand the risk and plan accordingly. They should maintain proper trade size relative to their portfolio size and risk tolerance.
Conclusion
Remember: when an option reaches its strike price, the investor still owns it. They can then choose to exercise it – a call option to buy the underlying asset, or a put option to sell.
Options are not guaranteed. There’s risk involved. Do your research, understand your investment, and know what happens when an option hits its strike price. Then you can make informed decisions.
Frequently Asked Questions
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Q: What is a strike price?
A: The strike price is the price at which the option buyer can buy or sell the underlying asset.
Q: What happens when an option hits the strike price?
A: When an option hits the strike price, the option holder can exercise their option and buy or sell the underlying asset at the strike price.
Q: How does an option holder know when their option has hit the strike price?
A: An option holder can monitor the underlying asset’s price to determine when their option has hit the strike price.
