Understanding Options, Premium, and Strike Price

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

  • The Premium is the price paid by the option buyer to the option seller to enter into the contract.
  • The premium’s value is influenced by several factors:
    • Current price of the underlying asset
    • The strike price
    • Time remaining until expiry
    • Market volatility

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...

ScenarioOutcome
Price rises above strike price at expiryBuyer profits based on the difference between market price and strike price, minus premium
Price stays below strike price at expiryBuyer loses the premium paid; seller keeps the premium
Option expires worthlessBuyer 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