What are Options, Premium, and the Strike Price?
An option is a financial contract that gives the buyer the right (but not the obligation) to either buy (in the case of a call option) or sell (in the case of a put option) an underlying asset at a predetermined price within a specified time period.
Key Terms in Options Trading
Strike Price
- The Strike Price is a fixed price specified in the option contract.
- It determines the price at which the buyer of the option can either buy or sell the underlying asset when the option is exercised.
- The strike price plays a crucial role in determining whether the option is In-The-Money (ITM), Out-Of-The-Money (OTM), or At-The-Money (ATM).
Premium
Example: Ms. Radha’s Call Option
Let’s consider Ms. Radha’s trade:
- Underlying asset: XYZ stock
- Current market price: ₹100
- Strike price: ₹105
- Premium paid: ₹5
- Expiry date: 1 month
Ms. Radha anticipates that XYZ’s stock price will rise in the next month. The stock price rises to ₹120 by the expiry date.
- Ms. Radha can exercise the option to buy at ₹105 (strike price), even though the market price is ₹120.
- Profit calculation: ₹120 (market price) – ₹105 (strike price) – ₹5 (premium paid) = ₹10 profit per share.
However, if the stock price remains below ₹105 at expiry, Ms. Radha may choose not to exercise the option. Her maximum loss is limited to the premium paid, which is ₹5.
What if...
| Scenario | Outcome |
|---|
| Price rises above strike price at expiry | Buyer profits based on the difference between market price and strike price, minus premium |
| Price stays below strike price at expiry | Buyer loses the premium paid; seller keeps the premium |
| Option expires worthless | Buyer loses the premium; seller keeps the premium |
Tip: Always factor in the premium when calculating the potential profit or loss from options trading.
For a deeper understanding of Options, visit School of Stocks.
Last updated: 27 Jun 2025
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