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A strike price, also referred to as an execution price, represents the price at which a securities contract may be exercised, that is either bought or sold. It is most common in options trading. Options are derivative contracts that provide investors with the "option" to purchase or sell an asset, such as a stock, when it reaches a strike price. When used effectively, an options strike price can significantly enhance an investors holdings, but under certain conditions may also seriously hurt returns.
In options trading there are two types of contracts, including a call option and a put option. A strike price in a call option represents the price at which the security can be purchased through the contract's expiration date. Conversely, a strike price on a put option determines the price at which a contract may be sold within the life of the contract.
There are two price components to an options contract. One is the market value of a security, that is the price where the underlying security in an option, such as a stock, trades in the financial markets. The other price component is the strike price, which represents where an underlying security in the options contract may be bought or sold.
An options contract alone does not carry with it any value. It is the underlying security or asset, such as a stock, within the options contract that determines its value. The difference between the stock's market value and the execution price becomes the profit per share that an investor earns when an options contract is sold.
When the strike price in a call option is below the stock market price, the contract is considered to be trading "in the money". If the execution price rises above the stock market value, however, the contract is deemed to be trading "out of the money." Since options investors aim to purchase securities below the stock market value, it does not make sense to buy when the option it is trading out of the money.
A contract on a put option is trading in the money when the strike price is higher than where the underlying security trades in the stock market if the underlying security is a stock. If the stock market value rises above the execution price, this contract is trading out of the money. Returns are compromised if a contract is sold out of the money.
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