While there’s a lot of money to be made on the stock market, millennials just aren’t taking part the way older generations do.
Much of that has to do with how complicated it can be to understand the terminology and what it costs to get started. Strike price options can be lucrative but there’s a pretty steep learning curve before it starts to pay off.
If you’re considering investing in options to start growing your personal wealth, follow this guide.
Understanding Strike Price
Options can only be acted upon under strict circumstances. These are often set by an “exercise price” which is when decisions can be made on an option. There’s also a time when options expire, meaning you need to invest or trade by a certain set time.
The strike price is going to determine how your option trade offers returns or how much it ends up costing you.
If you’ve found a stock you want to make an options trade on, your strike price is going to determine how much risk you take and how much reward you see. The basic goal is to get in when the value is low but knowing that it’s going to climb high. It’s a safe bet to buy-in once it’s hit a peak, but you’re less likely to see serious returns from your strike.
Understand Extrinsic and Intrinsic Value
Options strikes are made based on different types of values. Sometimes they’re made because of extrinsic value, sometimes intrinsic value, but commonly a mixture of both.
Extrinsic value is calculated based on time and the volatility of an option. Until the expiration of an option, there’s always some level of extrinsic value in an option.
The intrinsic value is what it’s worth when it expires. If there’s a strike allowing option owners to get discount shares, there’s intrinsic value. If the strike allows option owners to sell shares higher than the market, there’s also intrinsic value.
Pure Extrinsic Value
When an option is based on pure extrinsic value, it’s considered “out of the money”. When this option expires, it has no real worth.
A “call” means that a strike is above the stock price. A “put” is a strike that’s below the stock price. Ultimately, no one is going to buy shares of a stock above market price or sell below the market price if they can avoid it.
The reason these options are “out of the money” is that they’re worthless at expiration.
Option sellers appreciate this because it means they’ve made a profit. Buyers are less happy about this type of situation though because it means the options they’ve bought have turned to seed.
Get “In the Money”
When your options have guaranteed intrinsic value, they’re going to be considered “in the money”. When options have intrinsic value, they usually have some extrinsic value to go along with that.
Calls that are below the stock price or puts that end up above the stock price are both in the money.
The options “in the money” with the lowest extrinsic value exist when options trade like a long or short stock. This also applies when options that are just about the expire.
Sellers want their options to expire “out of the money” to earn the most profit. Sellers might have to buy back an option for a higher price than the sold it for, which is tricky as it can easily turn into a loss.
How to Tolerate Risk
Risk is all a part of dealing in options. Mitigating risk requires you to consider when an option is in the money, out of the money, or at the money.
In the money options are the most volatile in that they’re sensitive to the price of the underlying stock. However, the most can be gained when the stock price increases.
An at the money or out of the money option wouldn’t gain as much. Calls that are in the money have higher intrinsic values. Even if the stock declines, if it only goes down a modest about before it expires, you can recoup part of the investment. It all depends on how you manage your personal risk-reward balance.
Making Risk Pay Off
When a stock surges beyond the stroke price, your out of the money call will offer a large gain than your in the money call. However, there’s a lower chance of success with an out of the money call.
An in the money call is less risky but it’s more costly. Staking a small amount of money on a call trade, you’re going to get more from an in of the money call. It’s more likely you’re going to lose that money but if you want to get a feel for dealing with out of the money calls, start off small.
Conservative investors deal mostly with an in the money option. At the money options give you a reliable amount of return but are less exciting than an out of the money call. Deciding which works for you depends on your financial goals and how much risk you can handle taking.
Strike Price Options Should Be Informed
Experienced options traders know to take advantage of every piece of information they can before investing or trading. However, the market can be volatile when dealing with the most potentially lucrative options. Knowing about strike price options can ensure that you make a smart move with your money.
If you want to improve your options trading, check out our guide for tips.