Table of Contents
SERIES 7 PREP | FINANCIAL REGULATION COURSES
The strike price — also called the exercise price, the two terms being used interchangeably throughout the options industry and on the Series 7 examination — is the predetermined fixed price at which the holder of a call option has the right to purchase the underlying security, or the holder of a put option has the right to sell the underlying security, upon exercise of the contract.
It is the single most important contractual parameter of any options contract — more fundamental even than the premium, which fluctuates constantly with market conditions — because the strike price is fixed at the time the option contract is created and remains permanently unchanged throughout the life of the contract regardless of how the underlying security's price moves, how interest rates change, or how implied volatility fluctuates.
The relationship between the strike price and the current market price of the underlying security at any moment determines the option's moneyness — whether the option is in the money, at the money, or out of the money — which in turn determines whether the option has intrinsic value and how that intrinsic value is calculated. Every options calculation tested on the Series 7 examination — maximum gain, maximum loss, breakeven points, intrinsic value, and exercise decisions — derives directly from the relationship between the strike price and the underlying stock price.
The defining characteristic of the strike price is its permanence. Unlike the market price of the underlying security, which changes continuously with each trade, the strike price of an option contract is established at the contract's creation and cannot be altered by any subsequent market development short of specific corporate actions that trigger OCC adjustment procedures.
When an investor buys a call option with a fifty dollar strike price on a stock currently trading at forty-eight dollars, the strike price is fifty dollars today, fifty dollars when the stock rises to seventy dollars, fifty dollars when the stock falls to thirty dollars, and fifty dollars on the expiration date regardless of where the stock is then trading. The strike price is an immovable anchor — all analysis of the option's profitability, intrinsic value, and exercise decision is conducted relative to this fixed reference.
This permanence of the strike price while the underlying market price moves is the source of the option's leveraged risk-reward characteristics. A call option with a fifty dollar strike provides the holder with the economic benefit of any price appreciation above fifty dollars at a cost equal only to the premium paid — not the full purchase price of the stock. If the stock rises to seventy dollars, the call holder can exercise at fifty dollars and immediately benefit from the twenty dollar per share spread — a forty percent price movement in the stock produced a much larger percentage gain on the option premium, illustrating the leverage that the fixed strike price creates relative to owning the underlying stock outright.
Intrinsic value is the immediate economic benefit that would be realised by exercising an option at the current moment — the amount by which the option is in the money. Intrinsic value can never be negative — an option that is out of the money has zero intrinsic value because the holder would simply not exercise in that situation. The calculation of intrinsic value directly uses the strike price as one of its two inputs.
For a call option, intrinsic value equals the current market price of the underlying security minus the strike price — but only when the result is positive. If the result is zero or negative, intrinsic value is zero.
Call intrinsic value equals the greater of zero or stock price minus strike price.
For a put option, intrinsic value equals the strike price minus the current market price of the underlying security — but only when the result is positive. If the result is zero or negative, intrinsic value is zero.
Put intrinsic value equals the greater of zero or strike price minus stock price.
Four worked examples make the calculation precise across all scenarios. First — a call option with a fifty dollar strike on a stock trading at sixty dollars has intrinsic value of ten dollars — sixty minus fifty equals ten. Second — a put option with a fifty dollar strike on a stock trading at sixty dollars has intrinsic value of zero — fifty minus sixty is negative ten, but intrinsic value cannot be negative. Third — a call option with a fifty dollar strike on a stock trading at forty dollars has intrinsic value of zero — forty minus fifty is negative ten, so intrinsic value is zero. Fourth — a put option with a fifty dollar strike on a stock trading at forty dollars has intrinsic value of ten dollars — fifty minus forty equals ten.
The total premium of an option equals its intrinsic value plus its time value — the time value representing the additional amount investors pay above intrinsic value for the possibility of further favourable price movement before expiration. As expiration approaches and time runs out, time value decays toward zero, and at expiration the premium equals only the intrinsic value — the option is worth exactly what it is in the money by, and nothing more.
Moneyness is the classification of an option's relationship to the current market price of the underlying security relative to its strike price. Understanding the three moneyness categories — in the money, at the money, and out of the money — and how they apply differently to calls and puts is among the most foundational and most consistently tested concepts in the entire options curriculum of the Series 7 examination.
In the Money
An option is in the money when it has positive intrinsic value — when exercising it immediately would produce an economic benefit.
A call option is in the money when the current stock price is above the call's strike price. The holder of a call with a fifty dollar strike can exercise to buy shares at fifty dollars when the stock is trading at sixty dollars — immediately realising the ten dollar per share spread. Every dollar by which the stock price exceeds the call's strike price adds one dollar of intrinsic value to the call.
A put option is in the money when the current stock price is below the put's strike price. The holder of a put with a fifty dollar strike can exercise to sell shares at fifty dollars when the stock is trading at forty dollars — immediately realising the ten dollar per share spread. Every dollar by which the stock price falls below the put's strike price adds one dollar of intrinsic value to the put.
In-the-money options carry higher premiums than at-the-money or out-of-the-money options because they contain intrinsic value in addition to time value. Deep in-the-money options — whose strike prices are far from the current stock price in the favourable direction — behave increasingly like the underlying stock itself because their delta approaches one for calls and negative one for puts.
At the Money
An option is at the money when its strike price equals or is approximately equal to the current market price of the underlying security. At-the-money options have zero intrinsic value — there is no immediate economic benefit from exercising because the exercise price equals the current market price — but they carry the maximum time value of any option at the same expiration. At-the-money options are the most sensitive to changes in the underlying stock price because they sit at the inflection point where any price movement immediately converts the option from out of the money to in the money or vice versa. Delta for at-the-money options is approximately zero point five for calls and negative zero point five for puts — reflecting the approximately equal probability of the option finishing in or out of the money at expiration.
At-the-money options are the most actively traded of any moneyness category for most underlying securities because they offer the most balanced exposure between the benefit of price movement and the cost of time decay, making them the default reference point for discussions of options pricing and volatility measurement.
Out of the Money
An option is out of the money when it has zero intrinsic value — exercising it immediately would produce no economic benefit because the strike price is unfavourable relative to the current market price.
A call option is out of the money when the current stock price is below the call's strike price. Exercising a call with a fifty dollar strike when the stock trades at forty dollars would require paying fifty dollars for a forty dollar stock — the holder would not exercise and the option has zero intrinsic value.
A put option is out of the money when the current stock price is above the put's strike price. Exercising a put with a fifty dollar strike when the stock trades at sixty dollars would require selling shares at fifty dollars when they are worth sixty — the holder would not exercise and the option has zero intrinsic value.
Out-of-the-money options carry only time value in their premiums — they are cheaper to purchase than in-the-money or at-the-money options but require more movement in the underlying to become profitable and have a higher probability of expiring worthless.
The following relationships must be memorised precisely for the Series 7 examination.
For a call option — in the money when stock price is greater than strike price; at the money when stock price equals strike price; out of the money when stock price is less than strike price.
For a put option — in the money when stock price is less than strike price; at the money when stock price equals strike price; out of the money when stock price is greater than strike price.
The memory aid most commonly used — calls profit when the stock rises above the strike, puts profit when the stock falls below the strike — reflects the directional relationship precisely and should be the first analytical tool applied to any moneyness question on the examination.
Exchange-listed equity options do not have arbitrary strike prices — the Options Clearing Corporation and the listing exchanges establish standardised strike price intervals that ensure coherent, liquid markets across a range of strike prices for each listed underlying security.
For stocks trading below twenty-five dollars, strike prices are typically listed in one dollar increments. For stocks trading between twenty-five and two hundred dollars, strike prices are typically listed in five dollar increments. For stocks trading above two hundred dollars, strike prices are typically listed in ten dollar increments.
Exchanges may also list options with two dollar and fifty cent strike increments for highly active options classes. The Penny Pilot Programme extended by the SEC allows certain high-volume options to trade with penny-wide bid-ask spreads and may feature one dollar strike intervals regardless of the underlying stock price.
New strike prices are added periodically as the underlying stock price moves — when a stock rises or falls sufficiently, the OCC and exchanges add new strike prices above or below the existing listed range to maintain coverage of the relevant moneyness spectrum around the current stock price.
The OCC's standardised procedures govern adjustments to strike prices and contract multipliers when corporate actions affect the underlying security. The governing principle is that the economic value of every existing option contract must be preserved — no option holder should gain or lose economic value solely as a result of a corporate action in the underlying security.
Stock splits require strike price adjustments — in a two-for-one split, all existing option contracts are adjusted so that each contract now covers two hundred shares at one-half the original strike price. A call contract with a fifty dollar strike covering one hundred shares becomes a call contract with a twenty-five dollar strike covering two hundred shares — the total economic value of the contract is unchanged. Stock dividends are treated analogously.
Ordinary cash dividends do not trigger OCC adjustments — option premiums reflect the expected dividend through the options pricing model and the stock price declines on the ex-dividend date as expected. However special large cash dividends — typically representing more than ten percent of the underlying stock's value — do trigger OCC adjustments that reduce strike prices by the special dividend amount.
Every maximum gain, maximum loss, and breakeven calculation for a basic options position uses the strike price as its primary input. The following framework covers all four basic positions and must be mastered completely for the Series 7 examination.
For a long call — buying the right to purchase at the strike price — the breakeven at expiration equals the strike price plus the premium paid. Maximum gain is theoretically unlimited — any stock price above the upper breakeven produces profit growing dollar for dollar with the stock. Maximum loss equals the total premium paid — if the stock is below the strike at expiration the call expires worthless.
For a long put — buying the right to sell at the strike price — the breakeven at expiration equals the strike price minus the premium paid. Maximum gain equals the strike price minus the premium paid multiplied by one hundred — achieved if the stock falls to zero. Maximum loss equals the total premium paid — if the stock is above the strike at expiration the put expires worthless.
For a short call — the obligation to sell at the strike price if exercised — the breakeven equals the strike price plus the premium received. Maximum gain equals the premium received — if the stock is below the strike at expiration the call expires worthless and the writer retains the full premium. Maximum loss is theoretically unlimited — the writer must sell at the strike price regardless of how high the stock has risen.
For a short put — the obligation to buy at the strike price if exercised — the breakeven equals the strike price minus the premium received. Maximum gain equals the premium received — if the stock is above the strike at expiration the put expires worthless. Maximum loss equals the strike price minus the premium received multiplied by one hundred — achieved if the stock falls to zero and the writer must purchase worthless shares at the strike price.
Delta — the option Greek measuring the sensitivity of the option price to a one dollar change in the underlying security price — is directly related to the option's moneyness and therefore to its strike price's relationship to the current stock price.
Deep in-the-money calls have delta approaching one — the option price moves approximately dollar for dollar with the stock because the option is almost certain to be exercised. Deep out-of-the-money calls have delta approaching zero — the option price barely responds to stock price movements because the probability of the option ever reaching the money is very low. At-the-money calls have delta of approximately zero point five — the option price moves approximately fifty cents for each one dollar move in the stock.
The strike price selection therefore determines the option's effective leverage — a deep in-the-money call with high delta provides less leverage but more certainty of profit from stock appreciation, while a deep out-of-the-money call with low delta provides extreme leverage on the rare occasions when the stock makes a very large move but has a high probability of expiring worthless.
In the employee stock option context — covered in the Stock Option entry of this dictionary — the strike price carries additional regulatory significance. Under IRC Section 422, an incentive stock option must be granted at a strike price at or above the fair market value of the company's stock on the grant date — at least one hundred and ten percent of fair market value for ten percent or greater shareholders. Under IRC Section 409A, a non-qualified stock option granted at a strike price below the fair market value on the grant date is treated as a deferred compensation arrangement subject to immediate income inclusion and a twenty percent additional tax penalty — creating a powerful regulatory incentive for companies to set option strike prices at or above fair market value at all times.
The strike price is tested on the Series 7 examination as the foundational reference point for every options concept — moneyness, intrinsic value, breakeven, maximum gain, and maximum loss all derive from the relationship between the strike price and the underlying stock price.
The key points to retain are these.
The strike price — also called the exercise price — is the predetermined fixed price at which a call option holder may buy or a put option holder may sell the underlying security upon exercise. It is established at the contract's creation and remains unchanged throughout the contract's life — it is the permanent fixed reference point against which all option analysis is conducted.
Call intrinsic value equals the greater of zero or stock price minus strike price — positive only when the stock price exceeds the strike. Put intrinsic value equals the greater of zero or strike price minus stock price — positive only when the strike price exceeds the stock price. Total premium equals intrinsic value plus time value — at expiration the premium equals only intrinsic value as time value has decayed to zero.
Moneyness for calls — in the money when stock price is above the strike; at the money when equal; out of the money when stock price is below the strike. Moneyness for puts — in the money when stock price is below the strike; at the money when equal; out of the money when stock price is above the strike. In-the-money options carry intrinsic value plus time value. At-the-money options carry maximum time value with zero intrinsic value. Out-of-the-money options carry only time value with zero intrinsic value and the highest probability of expiring worthless.
OCC standardised strike price intervals are one dollar increments for stocks below twenty-five dollars, five dollar increments for stocks between twenty-five and two hundred dollars, and ten dollar increments above two hundred dollars.
Corporate actions trigger OCC adjustments that preserve the economic value of existing option positions — a two-for-one stock split halves all strike prices and doubles the contract share count to two hundred shares.
Breakeven for a long call equals strike plus premium paid. Breakeven for a long put equals strike minus premium paid.
Breakeven for a short call equals strike plus premium received. Breakeven for a short put equals strike minus premium received. Delta for at-the-money options is approximately zero point five for calls and negative zero point five for puts — approaching one or negative one for deep in-the-money options and approaching zero for deep out-of-the-money options.
