In the options market, a strike price (or exercise price in the Australian options market) refers to a fixed price that options will get bought or sold.
Basically, when someone buys a call option, he holds a right to exercise that option to buy 100 shares of stock at the strike price of that call option. On the other side, the option seller who gets exercised will be obligated to deliver 100 shares at that price.
This is simply a right to do so. It does not mean if chose to exercise; the option owner will make profit.
Strike of options is generally formulated as the following:
– If the stock price is higher than $100, the strike price is in the intervals of 10, i.e.: $100, $110, $120…etc
– If the stock price ranges from $25 to $100, it is in the intervals of 5, i.e. $25, $30…, $50, $55, $60…, $90, $95.
– If the stock price is lower than $25, it is in the intervals of 2.5, i.e. $17.7, $20 and $22.5.
Strike also reflects the liquidity of the option itself. That’s why you will see a number of stocks that don’t follow the formula above. For instance, at the point of this writing Microsoft (MSFT) trading at $28 has $1 strike price increment. Also Proctor & Gamble (PG) at the point of this writing trading at $60 has $1 strike price.
Sometimes, an unexpected event like a stock split at the ratio of 2 to 1 or 3 to 2 can result in odd number like a $2.5 or $3. It is because when the underlying stock gets split, the options get split too.
If you own one $55 strike call options contract and the stock gets split from $50 to $25, you will end up owning 2 $27.5 call options contracts. The value won’t change but your contract size and strike price do.
However, once you start trading and gain some experience, you will know strike prices don’t matter that much. What matters is your risk and rewards analysis, control of emotion and continuation of learning and refining your skills.