Candlestick Trading Blog
|The use of the word strike to mean that a business deal has been consummated goes back to horse traders in Ireland slapping hands when a price was agreed on. In today’s world of traders the strike price is the agreed upon price of futures, commodities, or options contracts. This price differs from the current price of the underlying stock or commodity which is called the spot price. It is the divergence of spot price from strike price that leads to profit and loss in buying and selling options or trading futures. Understanding the moving relationship between strike price and spot price is a key to understanding the stock market.
The strike price stays put while the stock market, commodity market, or futures market move in response to the news of the day, fundamental analysis projections, and technical stock trading. This price is what a contract will be settled at, whether trading is European style in which contracts are settled at expiration or United States style in which the buyer of an options contract can exercise the contract at any point during the contract’s term. So, what determines the price at which a contract will be settled? When options are offered they are based upon the current price of the underlying stock, commodity, or future. Often a range of options is offered in steps going up for the current price. Traders will then decide on whether to buy or sell and whether to deal in puts or calls based upon their own projections of whether the equity underlying the contract will be higher or lower priced by the time the contract expires.
The strike price is also referred to as the exercise price because it is the price at which the contract will be exercised no matter what current stock market prices or prices of futures and commodities will be. As time advances toward the expiration date a contract is said to be in the money, at the money, or out of the money depending upon whether the spot price is above or below the strike price. However, this varies with whether the trader is buying puts or buying calls.
Basically in, at, or out of the money refer to what would happen if you were to exercise the contract today. A trader who buys call options and finds that the underlying stock prices go up over the exercise price will have contracts that are in the money. An options trader who buys put options on stocks will be in the money with the options if the prices of the underlying stocks in the equity market go down in price. The old term for whether or not a contract is currently profitable is the moneyness of the contract. In all of this the exercise price does not budge. It is the spot price that determines profit or loss and the spot price is driven by stock market news, those engaged in long term investing, and technical traders in search of short term profits.
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