What is a strike price?
The stated price per share for which underlying stock may be purchased (for a call) or sold (for a put) by the option holder upon exercise of the option contract. If the strike price is below the price at which the stock is trading on the open market, the option holder may be able to make a profit. If the stock price on the open market is below the strike price, the options are said to be "underwater". It would make no sense to exercise an "underwater" option because that would mean buying the stock through the stock option at a higher price than you would pay on the open market.At any given time, there is simultaneous trading in a number of different call and put options--different in terms of delivery months and strike prices. Option delivery months are typically the same as those of the underlying futures contract.
Strike prices are listed in predetermined multiples for each commodity. The listed strike prices will include an at or near-the-money option, at least five strikes below, and at least nine strikes above the at-the-money option. At-the-money is defined as an option whose strike price is equal--or approximately equal--to the current market price of the underlying futures contract. The five lower strikes would follow normal intervals. The nine higher strikes would include five normal intervals above the at-the-money option(s), plus an additional four strikes listed in even strikes that are double the normal interval. As prices increase or decrease, additional strike prices are listed as needed so that there are always five strike prices listed in normal intervals and four strike prices in double intervals above the current futures price, and at lease five strike prices below the current futures prices.
An important difference between futures and options is that trading in futures contracts is based on prices, while trading in options is based on premiums. The premium depends on market conditions such as volatility, time until expiration, and other economic variables affecting the value of the underlying futures contract. How various factors influence premiums and how and to what extent market price declines are offset by option profits are among the topics to discuss in detail with a broker.
The premium is the only part of the option contract negotiated in the trading pit; all other contract terms are predetermined. For an option buyer, the premium represents the maximum amount that he or she can lose, since the buyer is limited only to his initial investment. For an option seller, however, the premium represents the maximum amount he or she can gain, since the option seller faces the possibility of the option being exercised against him or her. When an option is exercised, the futures position assigned to an option seller will almost always be a losing one, since only an in-the-money option will normally be exercised by the option buyer.
