Stock options are one of the major investment instruments in the derivative stock market. And many investors are taking an interest in options in current times, in 2022, 29.33 futures contracts are traded globally. In options trading, investors can sell or buy options (security) at a predetermined price before they expire. An option’s premium or strike price is used to sell or buy the options (when exercised).
The strike price of an option determines its cost as well as whether the option can be profitable for investors or not. Therefore, if you want to invest in options, you must efficiently calculate the strike price for your options Algo trading; if not, do not worry. Here we will discuss 6 important factors influencing strike prices and much more. So, let’s start exploring.
What Are Stock Options?
Before we talk about six important factors influencing the strike price of stock options, let us briefly discuss what stock options are. Stock options are derivative securities that allow traders to buy or sell the underlying asset at a set price within the expiry date. And as a return, the trader who sells the options gets the option premium (options premium) at the time of the contract.
Two primary stock options are available for trading- call and put. Call options allow traders to buy the underlying asset at a specific price on or before the expiry date. In contrast, put options enable traders to sell underlying assets by the expiry date at a fixed price.
What Is The Strike Price Of An Option?
An option’s strike price is the price at which traders can exercise their right to purchase or sell the underlying asset. The strike price is the only determiner of the price the option owner will receive when they exercise the right. The strike price of a stock option is determined upon various factors and set at the time of the contract. Primarily, the strike price is equal to the company’s stock FMV or Fair market value on the day when the stock option is granted. And the stock owner has the right to exercise their right at the time of the contract grant to its expiry date.
And if the option owner wants to exercise their right, they must calculate the strike price of their options. However, you must note that depending upon several factors like market fluctuation, volatility, and others, the strike price of an option can digress from its fair market value. Thus, if you want to enter the options trading market, you must learn to calculate the strike price of the stock options. Also using an options strategy builder can help you make a viable trading strategy.
Understanding Stock Options and Strike Price
An option is a derivative security contract that gives the holder the right to buy or sell options at a predetermined price within or at the expiry date. However, they are not obligated to exercise this right. For example, as an options trader, when you purchase a stock option of a company, you gain a stake in that particular company but without the obligation to purchase the shares of the company.
In this trade, investors gain from the appreciated stocks of the company by selling it at a profitable price. However, they must trade within the expiry day, or the contract will be invalid. And there will be no obligation to purchase or sell at the pre-decided price. And the strike price is the price at which the investor can buy or sell the option. And this right to sell or buy the option will be automatically at the pre-decided price.
Six Important Factors Influencing The Strike Price of Options
We have learned about stock options and strike price and their relationship. We have also seen that several factors can affect the strike price of the stock option. And below, we will discuss six important factors influencing the strike price calculation. Knowing them will help you use your options trading app and build a profitable strategy. Also, keeping these factors in mind will help you make the most of your options strategy builder app.
- Expiry date
The expiry date is a crucial factor indicating a particular time frame in which an option holder can exercise their right to sell or purchase the underlying asset. Usually, when the expiration date is long, the option’s strike price remains high while the expiry day is short, and the option’s strike price will also be low. Therefore, as an options trader, you must know the option’s expiry date to make an informed decision. In addition, you must also remember that once the option crosses its expiry date, it becomes worthless, and the contract becomes invalid. So, always consider the expiry date while calculating the strike price of your options using an options trading app.
Volatility or market volatility is another crucial factor that affects strike prices. Market volatility is also known as fluctuations in the stock price or index in the market. And when the market volatility peaks, the options strike price movement starts to fluctuate. This leads to higher trade risk and uncertainty. Plus, the strike price of each underlying asset is different. So, you must always research and learn about volatility in the stock options you want to trade. Also, you must remember this while using your Algo trading app to build a viable trading strategy.
- 409A valuation
The 409A valuation ascertained the Fair Market Value or FMV of the stock when it was granted. 409A valuation is a most precise method than a traditional appraisal. In 409A valuation, the appraisal or financial organization considers various factors, such as earnings, cash flow, taxes, etc., to calculate the FMV of the company’s stocks. However, they cannot adjust the figures during the valuation. Therefore, the fair market value of the company’s stock options is counted as a determiner factor while calculating the strike price. And if you use an options Algo trading app, you can use this method to calculate the strike price for your trade.
- Interest rate
Interest rate is another crucial factor that influences the strike price calculation. Interest rate is a measurement of return on a fixed security or asset. The interest rate on commodities, stocks, and indices is directly linked to the market, making them heavy in risk and liquidity. As a trader, you must know what applies to the underlying asset and whether it can affect the strike price. For instance, every time the interest rate increases, the value of put options falls while the call options value rises. Thus, you need to consider the interest rate while calculating the strike price on your options strategy builder app to make your trade effective and profitable.
- Underlying asset’s price
The value of an option is directly associated with the underlying asset’s price. The stock option’s strike price is connected with the underlying asset’s price. And when the underlying asset’s price falls, the put option price also falls. On the other hand, when the underlying asset’s price increases, the call options strike price also goes high. Thus, the underlying asset’s price is vital when calculating the strike price. And you must consider this factor while building your options trading strategy with an Algo trading app.
The dividend is the payment companies give off to their shareholders. And in 2020, information and Communication paid 6$ billion to the shareholders as dividends. However, the option holders do not have any access to the payment. Still, options traders must consider the dividend and its impact on the option while calculating the strike price. The dividend is also a major factor influencing the strike price, and you should consider it while building your options trading strategy with an options trading app.
Strike price plays a crucial role in deciding the option’s value. An option’s strike price means the option’s pre-decided price, which the investor can exercise within or at the expiry date to sell or buy the option. In addition, several factors include volatility, underlying asset price, interest rate, etc. And as an options trader, you must consider all these factors while calculating the strike price and making a viable trading plan. In this blog post, we have shared six important factors influencing the strike price. Also, we have discussed stock options, strike price, and their connection. Remember that when you use the options strategy builder app, you must consider all these factors to make your trade profitable.