Income investors need to know about option strike prices to optimize their trades. Here are some basics…
Stock option strike prices are the price stated on each call or put option. The strike prices can be classified according to their relationship with the current stock price. There are three categories:
- In the money (ITM) defined as calls with strike prices below stock prices and puts with strike prices above stock prices;
- At the money (ATM) defined as the call and put strike price at or near the stock price;
- Out of the money (OTM) defined as calls with strike prices above the stock price and puts with strike prices below the stock price.
As you know, an option will move from category to category based on its relationship with the actual stock price movement. For example, when a stock is trading at $50 the the $50 strike prices will be at the money. When the stock price moves above $50, calls will be ITM while puts will be OTM. Likewise, when the stock price falls below $50, then calls will be OTM and puts will be ITM. Therefore, the category is totally dependent on the current stock price.
OTM options expired worthless while ITM will always be exercised by the holder because they still have a value at or near the expiration date. When a stock option is exercised, the call holder buys the stock and the put holder sells the stock. When options are exercised, the OCC decides to which brokerage firm the option will be assigned and the brokerage decides which customer will get the assignment. When you are assigned an exercise, those shares are said to have been called away or called out.
When stock options are American style, you can be assigned an exercise anytime the option is ITM. Of course, early exercise is affected by the time value remaining on the option. As time value begins to decline more rapidly as expiration nears, the holder is more likely to assign an ITM option. In general, 10% of options are exercised, 60% are traded out and 30% expire worthless.
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