What is an Exercise Price (Strike Price)?
The exercise price — commonly called the strike price — is the fixed price at which the holder of an option can buy (call) or sell (put) the underlying security when exercising the option. The strike is set when the option is created and is one of the main determinants of an option’s value: an option’s worth depends on the relationship between the strike and the underlying market price.
Source: Investopedia — Exercise Price (https://www.investopedia.com/terms/e/exerciseprice.asp)
Key takeaways
– The exercise (strike) price is the price at which an option holder can buy (call) or sell (put) the underlying asset.
– An option’s value is driven by the difference between the underlying’s market price and the strike (intrinsic value) plus any extrinsic (time/volatility) value.
– Calls are in the money (ITM) when underlying price > strike; puts are ITM when underlying price strike (exercising lets holder buy below market).
– OTM if underlying price < strike (exercising would be paying more than market).
– Put:
– ITM if underlying price strike (exercising would be selling below market).
Worked example (simple)
– Sam buys a WFC call with strike $45 while WFC trades at $50. The call is ITM by $5.
– If Sam paid a premium of $2 for the call:
– Intrinsic value = 50 − 45 = $5
– Profit on exercise = (Intrinsic value) − premium = 5 − 2 = $3 per share
– Breakeven at expiration for buyer = strike + premium = $45 + $2 = $47
– If strike = $55 while WFC = $50, the call is OTM and exercising is not sensible (you could buy for $50 in the market).
Practical steps — when and how to use the exercise price in decision making
1) Choosing a strike when opening a position
– Define objective: speculation (leverage), income (selling), or hedge (protective put).
– Consider risk/reward:
– OTM strikes are cheaper (lower premium) but need a larger move in the underlying to become profitable — higher leverage and lower probability.
– ITM strikes are more expensive but have more intrinsic value and behave more like the underlying price movement.
– Calculate breakeven:
– Call breakeven = strike + premium paid
– Put breakeven = strike − premium paid
– Check liquidity: prefer strikes with tight bid/ask spreads and sufficient volume/open interest.
2) Before expiry: “sell-to-close” vs “exercise-to-acquire” (holders)
– Often the better choice is to sell the option rather than exercise. Reasons:
– Selling captures intrinsic plus remaining extrinsic value; exercising converts only intrinsic value into stock and discards remaining extrinsic value.
– Exercising requires funds to buy the underlying (for calls) or requires delivering/owning shares (for puts).
– When to exercise early (calls):
– Rare for American calls, but may be optimal to exercise early to capture a dividend when the ex‑dividend benefit outweighs lost time value.
– To obtain voting rights or to meet corporate event obligations.
– When to exercise early (puts):
– Even rarer; sometimes exercised to raise liquidity or when immediate delivery of cash is needed.
– Practical step: compare proceed of selling the option in market vs net value from exercising (intrinsic − transaction costs). Choose the higher.
3) For option sellers (writers) — be prepared for assignment
– If you sold a call and it is ITM at expiration (or sometimes early for American options), you may be assigned and obliged to sell the underlying at the strike.
– If you sold a put and it is ITM, you may be assigned and obliged to buy the underlying at the strike.
– Practical step: maintain margin/cash or stock to cover possible assignment. If assignment would cause unwanted positions, manage risk by buying back (closing) the short option before assignment risk increases.
4) Calculating profit/loss when exercising
– For a call exercised:
– Cost to acquire = strike price × shares + commissions
– Net position value = market price × shares − cost to acquire − premium initially paid (if already paid)
– Net profit per share = (market price − strike) − premium − transaction costs
– For a put exercised:
– Proceeds from sale = strike price × shares − commissions
– Net profit per share = (strike − market price) − premium − transaction costs
5) Know expiration and settlement rules
– Check whether the option is American-style (can be exercised any time until expiration) or European-style (exercisable only at expiration).
– Settlement can be physical (actual shares delivered) or cash-settled (cash difference is exchanged). Check contract specs.
– Practical step: review the exchange/broker contract specifications before trading.
Common practical checklists
If you are an option buyer considering exercising:
– Check intrinsic value versus option market price.
– Check remaining extrinsic value — if significant, selling may net more.
– Confirm funds are available (for call exercise) or that you are ready to deliver/receive shares.
– Consider tax, dividends, and corporate actions.
– Contact your broker or use the platform’s exercise feature before exercise deadlines.
If you are an option seller (short position):
– Monitor underlying price relative to strike, especially close to expiration.
– Maintain margin/cash and be ready for assignment.
– Consider rolling the position (buy to close and sell a further-dated option) to avoid assignment.
Practical examples — short scenarios
– Buyer bought a deep ITM call for hedging and wants stock exposure — exercise if they want to become long shares and can fund the purchase; otherwise sell the call and buy shares separately.
– Buyer owns stock and buys a protective put — if put becomes ITM near expiration and they want to lock in sale, they can exercise to sell at strike; alternatively, sell the put to capture remaining value then sell shares.
Costs, tax and other considerations
– Transaction costs and commissions reduce the benefit of exercise — factor them into profit calculations.
– Exercising can have tax implications (realizing gain/loss, affecting holding periods). Consult a tax advisor to understand consequences.
– Time value: exercising destroys extrinsic value — evaluate whether early exercise sacrifices more than it gains.
Common mistakes to avoid
– Exercising automatically without checking whether selling the option in the market is more profitable.
– Ignoring assignment risk when writing options — not having margin or shares available.
– Choosing strikes solely based on low premium without considering probability, liquidity, and breakeven.
Summary — practical rules of thumb
– Strike determines moneyness; moneyness drives intrinsic value and option behavior.
– Breakeven = strike ± premium (plus transaction costs).
– Selling the option usually captures more value than exercising because it retains extrinsic value — exercise only when there’s a clear advantage (e.g., capture a dividend, convert to stock, meet a hedge).
– Always check option style (American vs European), settlement method, liquidity, and costs before acting.
Further reading and source
– Investopedia — Exercise Price (Strike Price): https://www.investopedia.com/terms/e/exerciseprice.asp
If you’d like, I can:
– Walk through a personalized example using a specific stock, strike, and premium.
– Provide a short checklist you can print and use when deciding to exercise or close an option.