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Option Strike Price

 

In options, the strike price is the pre-determined price at which the option may be exercised. Strike price is also known as the exercise price. Strike is the price at which an option begins to have a settlement value at expiration. The strike price is set at the time the option contract originates.

An option is "in-the-money" when the current market price of the underlying futures contract exceeds the strike price of a call or is below the strike price of a put. Similarly, an option is "out-of-the-money" when the current market price of the underlying futures contract exceeds the strike price of a put or is below the strike price of a call.

 

Strike Price and Option Premium

 

Call and put option premiums depend upon several factors, the most important of which is the strike price of the option relative to the market price of the underlying futures contract. A call option becomes more valuable, and hence its intrinsic value becomes greater, as the market price of the underlying futures contract rises above the option's strike price. A put option becomes more valuable, and hence the intrinsic value becomes greater, as the market price of the underlying futures contract falls below the option's strike price.

The intrinsic value and time value together constitute the option premium. An option may or may not have intrinsic value, but it will almost always have time value. Any option may become valuable in the future and hence, a liability to the seller, so the time value exists to compensate option sellers appropriately. The major factors that influence the time value of an option are:

 

Time to Expiration

The longer the time to expiration of a call or put option, the larger the time value. This is because, with lots of time until expiration, the option has plenty of opportunity to acquire intrinsic value. On the flip side, as option approaches expiration, the time value, all else constant, will erode steadily to zero.

 

Volatility

As the underlying futures contract becomes more volatile, the time value of a call and a put option increase. This is because, as volatility rises, it becomes more likely that prices will move to the point where the option has intrinsic value.

 
 
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