Exercise Price: Overview, Put and Calls, In and Out of The Money

Exercise Price: Overview, Puts and Calls, In and Out of the Money

Key takeaways

• The exercise price (also called the strike price) is the price at which the underlying security can be bought (call) or sold (put) if the option is exercised.
• An option’s value depends on the relationship between the exercise price and the security’s market price.
• “In the money” (ITM) and “out of the money” (OTM) describe whether exercising an option would be immediately profitable.
• Intrinsic value measures the immediate exercise profit; extrinsic value reflects time value and potential future movement.

What is the exercise price?

The exercise (strike) price is fixed when an option is written and specifies the price at which the option holder can transact the underlying security:
* Call option: right to buy the underlying at the strike price.
* Put option: right to sell the underlying at the strike price.

An option’s market value is shaped by how the strike compares to the underlying’s market price.

Calls vs. puts

• Put: gives the holder the right, but not the obligation, to sell the underlying at the strike. Investors buy puts to speculate on declines or to hedge ownership against price drops.
• Call: gives the holder the right, but not the obligation, to buy the underlying at the strike. Investors buy calls to speculate on gains or to hedge short positions against rises.

Typically, holders exercise puts when the underlying is below the strike and exercise calls when the underlying is above the strike.

In the money (ITM) vs. out of the money (OTM)

• Call is ITM when underlying price > strike. Call is OTM when underlying price ≤ strike.
• Put is ITM when underlying price < strike. Put is OTM when underlying price ≥ strike.

ITM options have intrinsic value; OTM options have no intrinsic value and consist only of extrinsic value.

Intrinsic and extrinsic value

• Intrinsic value (if any) = immediate profit from exercising.
• Call intrinsic value = max(0, underlying price − strike).
• Put intrinsic value = max(0, strike − underlying price).
• Extrinsic value = option premium minus intrinsic value. It reflects time remaining, volatility, interest rates and the probability of future movement through the strike.

The farther an option moves OTM, the less valuable it is (only extrinsic value remains). The farther ITM, the greater its intrinsic value.

Example

If Sam holds a call with a $45 strike and the underlying stock trades at $50:
* The call is ITM by $5.
* Sam could exercise to buy at $45 and immediately have a $5 per-share advantage over the market price.
* Net profit from exercising equals the $5 intrinsic value minus the premium Sam paid for the option.

If the strike were $55 while the stock trades at $50, the call would be OTM and exercising would not be beneficial.

Summary

The exercise (strike) price is central to option valuation and strategy. Whether an option is in or out of the money determines its intrinsic value and strongly influences trading and exercise decisions. Understanding the relationship between strike, underlying price, and time/volatility helps investors assess an option’s worth and potential use for speculation or hedging.