To understand strike price better, let us once again look at futures.

In a futures contract, the buyer and seller agree to buy and sell an underlying stock on a future date. It is at a price that is agreed upon now. For any month, there can be only one futures contract. The buyer and seller agree on any price.

Options differ from Futures in that one can buy or sell an underlying stock only at prices fixed by the exchange called strike prices. There can be several option contracts with various strike prices. Let us say Infosys is now trading at Rs.1000. (spot price) It could have December option at strike prices of Rs.940, Rs.960, Rs.980, Rs.1000, Rs.1020, Rs.1040, etc. Usually, we find four or five strike prices on both sides of the spot price.

The buyer and seller can choose any strike price. For example, the December Call price of Infosys Rs.1040 would allow the option holder to buy Infosys shares at Rs.1040 any time before the expiry date. It doesn’t matter what its price may be at that time.

The following factors decide the strike prices. Time left for the expiry of the contract, the volatility of the stock, and the current interest rates. As the strike price is an essential component of an option contract, the fluctuation of prices in the market does not affect the strike price. The difference between the two strike prices could vary according to the asset type and market type.

WHY STRIKE PRICES?

Options are unique because it has a system of different fixed strike prices.

By definition, an option gives a right to the holder to buy the shares at a ‘fixed price’. So, without a strike price, there will not be a ‘fixed price’.

If there is only one strike price, the price would finally settle in favor of either holder or writer of call and put options. As it would become worthless for one of them, the liquidity of the options contracts gets affected.

Let us assume that, like in futures, instead of strike prices, options also were to have ‘marked to market’. For this, the strike price must keep changing every day, depending on the spot price of the underlying shares. Then, those hedgers who would want to have the right to buy or sell the shares at a fixed price cannot do so.

Why is strike price important.

The strike price of the option decides the moneyness of an option contract. It is a term used to describe the profitability of the option contract in connection with the spot price and the strike price of the shares. An option could be ‘in the money’ (profit) or ‘out of money’ (loss) or ‘at the money’ equal to the spot price.