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Exercise Price

Also referred to as the strike price, it is the price at which an underlying security can be bought (call option) or sold (put option).

 

Exercise price is a term that is critically important in derivatives trading because it helps investors determine whether or not they will ultimately make money from their investments. How? Any given option derives its value from the difference between an underlying security’s market price and its fixed exercise price.

 

In general, investors usually only opt to sell shares at the exercise price (put option) if the price of the underlying stock is below that exercise price. Similarly, investors usually only opt to purchase at exercise price (call option) if the price of the underlying security is above the exercise price. The difference between the underlying security’s price and the exercise price governs whether an option is “out of the money” or “in the money.”

 

EXAMPLE:

Options traders cannot quote “Jerry Maguire” because yelling “show me the money” confuses other traders who are only concerned about whether any given option’s exercise price and security price places the investment “in” or “out of” the money. Derivatives trading is, therefore, decidedly not fun. Also, the human head weighs eight pounds.