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Options trading can be one of the fastest ways to make serious money on a stock. And choosing the right options strike price can yield triple-digit gains in a matter of weeks.
For a relatively low price, the right options trading strategy can multiply the gains possible over simply buying or selling the underlying stock.
The secret is knowing the right options trade. And that involves choosing the right options strike price to use.
The strike price on an option is the price you will pay or receive if you exercise the option. For a call option, it's what you pay for the underlying stock if you exercise the option. For a put option, it's what you receive for the stock if you exercise the option. This is different from the price you pay for the option itself, which is called the premium.
As you can tell, the value of the option changes based on how close or far the stock's actual price is to the strike price.
There are three types of strike prices, or strikes, and they depend on where the underlying stock is trading at the time. They are:
- In the money (ITM) = The strike price is below the stock's current price for a call, or above it for a put. This means you can exercise the option for a profit.
- At the money (ATM) = The strike price is the same as the stock's price. This also includes strikes that are near the money, where the strike is very close to the stock's price.
- Out of the money (OTM) = The strike price is above the stock's price for a call, or below it for a put.
The value of each type of strike changes from day to day. ITM options have intrinsic value since the option can be exercised to purchase or sell a stock for a profit. In the case of a call option, if the stock's actual price is above the strike price, then you can earn the difference between those prices by exercising the option.
OTM options have no intrinsic value and are mostly comprised of time value. The longer an options contract has until expiration, the more time value it has. Time value means the option has the chance to become more valuable over time if the stock's price changes enough. If the underlying stock is the same price at options expiration as it is now, the option would be worthless.
ATM options also have no intrinsic value. They are typically the strike prices with the most trading activity because they offer the combination of time value and price that make them attractive to traders.
But this can seem abstract if you've never traded options.
Here's a real-world example using Apple Inc. (NASDAQ: AAPL) and its options to show what the different strike prices mean in practice.
Apple stock traded at $248.82 a few days ago. Let's see where the following call option strikes were at that time.
$245 call: in the money
$250 call: at the money (or near the money)
$255 call: out of the money
The $245 call had an intrinsic, or real, value since it was in the money. That means you had the right to buy shares of a stock trading at $248.82 for $245.00, netting a profit of $3.82 per share.
It also had time value, because the options have not yet expired. Apple's stock could've risen even higher, making the option more valuable.
Now, let's look at puts with the same strike prices with Apple stock still trading at $248.82.
$245 put: out of the money
$250 put: at the money (or near the money)
$255 put: in the money
In this case, the $255 put has real value. You have the right to sell a stock trading at $248.82 per share for $255 per share, making a profit of $6.18 per share.
Again, the more "in the money" an option is and the more time left to expiration, the more that option will cost. Conversely, the more "out of the money" an option is and the less time left to expiration, the less the option will cost.
By using different strike prices, with or without different expiration dates, you can customize your options trade to meet your specific investment goals.
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