What is a strike price?
The strike price is essentially the price at which the buyer will get shares of long stock (in the case of a call option) or sell shares of short stock (in the case of a put option). The premium associated with the option is added to the strike price in the case of the call option, or is subtracted from the strike price in the case of a put option.
Here’s another look at options basics from our Options Bootcamp:?Back to School, Back to Basics.
How do I choose a strike price?
Options are a way for investors to limit risk and position themselves in a stock in several ways.
Choosing an option is normally based on risk tolerance. In-the-moneys (ITM) are relatively expensive in comparison to out-of-the-money (OTM) and at-the-money (ATM) options. The OTM?s offer the lowest cost but with a lower probability (or Delta) whereas ITM?s are more expensive but come with a higher probability (or Delta).
In considering an option to purchase a trader takes into consideration the strike vs. the cost and the probability. He may choose to buy several of the OTM option with a lower probability but a greater leverage (reward) and still lower cost of buying one ITM or two ATM options.
How much a trader is willing to risk vs. the potential reward is a good practice.
In considering a short sale, the trader may want to sell an option against shares he owns or even sells the option ?naked.? In this case, the seller of the option against shares he owns is essentially trying to increase their rate of return by selling the call.
The seller of a ?naked? call tries to capture the premium of the option while assuming unlimited risk for the life of that contract.?