Exercise price (also known as strike price) is the price at which an option holder can call (purchase) or put (sell) the underlying asset.
The initial option premium and subsequent value of the option depend on the exercise price relative to the price of the underlying (asset). Relative to the price of the underlying asset, lower exercise price of a call option means higher option premium and higher call option value and vice versa. On the other hand, higher exercise price of a put option relative to the price of the underlying asset means higher option premium and higher option value and vice versa.
The following table summarizes quotes for call options and put options on Bank of America (NYSE: BAC) stock obtained from the delayed quotes counter of the Chicago Board Derivative Exchange website (cboe.com).
|Contract Name||Bid||Ask||Contract Name||Bid||Ask|
From the table you can follow that lower the exercise price of the call option, higher the value of the option and vice versa. This is because value of a call equals higher of zero or excess of the price of the underling over the exercise price, so lower exercise price gives a higher option value. The opposite happens with the put option, it has higher value at higher exercise price because value of put option equals the higher of zero or excess of exercise price over the price of the underlying asset.
Please note that CBOE uses strike price to denote an option's exercise price. Strike price and exercise price are synonymous terms.
Written by Obaidullah Jan, ACA, CFA