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An exercise price is the price at which a contract to buy an option is executed. It is a term used in investing when a person has secured an options contract and when that contract hits its strike price. The exercise price varies depending on the particular option purchased.
An option is a contract allowing the option buyer to purchase something at a set price. For example, a stock may be currently trading at $10 US Dollars (USD) per share. A person could pay money for an option contract to buy that stock at $11 USD per share. The cost for that option would be based on the market's belief that the stock would go up to or higher than $11 USD per share.
If the stock did in fact go higher than $11 USD per share, say to $12 USD per share, the buyer would exercise his option and he would then make a profit, as he would be able to buy the stock for a lower price than it was currently valued at. He would be buying the stock at $11 USD even though it was worth $12 USD, thus making an instant profit on the stock. He could also sell his option itself, thus selling to someone else the right to buy the stock for less than it was worth.
When an individual buys an option, he only wants to exercise it if it reaches the "strike" price or the price at which the option allows him to buy. For example, if he purchased the option to buy the stock at $11 USD per share but the stock went down to $9 USD per share, he would not wish to exercise his option since he would then be buying the stock at $2 USD more than what it was valued at. Instead, he would let the option expire and lose only the initial money he invested to buy the option. Most options expire within a set period, usually a month, although some may be longer.
The exercise price, therefore, is the price at which the person actually exercises his option or buys the stock at the price promised in the option contact. If a person bought an option contract to buy a share of stock at $10 USD, then the exercise price would be $10 USD. If the stock went over and above that exercise price of $10 USD per share, the contract would be exercised, and he would buy the stock and make his profit.
When I was studying to take my Series 7 exam, learning about options was the hardest section to understand.
Understanding the exercise price of options is easier than trying to figure out the time decay. It makes sense to me that once an option reaches a certain strike price, it can be exercised.
What becomes tricky is how fast that option reaches that strike price, or how much the option you have decreases in value the closer it gets to the exercise price.
This is one the biggest reason I have never done much options trading. Trading stocks can be risky enough, and once you add options to the mix, you really have to be careful.
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