Education 04: Options Price in relation to Stock Price

One of the components of an Option Contract is the Strike Price. This is the agreed upon price per the contract. For a CALL Contract this is the agreed upon price that the buyer can purchase shares at. For a PUT Contract, this is the agreed upon price that the buyer can sell shares at.

Example: MSFT CALL APR $40 allows the buyer to purchase MSFT shares at $40 anytime between the purchase of the option and expiration. MSFT PUT APR $40 allows the buyer to sell MSFT shares at $40 anytime between the purchase of the option and expiration.

The $40 is called the Strike Price. There are many different Strike Prices offered, so choosing one becomes an important part of trading options (more on that in a later blog). But the relationship between the Strike Price and the Stock Price helps drive the change in the option value.

Example: If MSFT was trading at $41.46, and you purchased a MSFT CALL APR $40 for $2.16, then if the price moves of MSFT goes up, the value of the CALL Option goes up.

The mechanics for PUT options are the same for CALL options (how they trade, how their value is determined, significance of how close to the Strike Price the Stock Price is, etc....). However, the major difference in that with a PUT option you are locking in a SELLING price for shares vs. a BUYING price for shares.

Simple Reminder: When you BUY PUTS, you want the Stock Price to go DOWN. As the Stock Price goes DOWN, the value of your PUT Option goes UP!

The reason for this is that with the PUT contract you have locked in a selling price (Strike Price). So, if you buy a MSFT PUT APR $42, you have purchased the right to sell shares at $42. If the stock price for MSFT goes lower, your contract becomes more valuable.

Example: You purchase MSFT PUT APR $42 when MSFT was trading at $41.46, and you paid $1.03 for the Option. Now, MSFT drops to $40. Your option gives you the right to sell shares at $42, even though you can only sell shares on the market for $40. So, you have a $2 value in your contract. And that value will get bigger as the stock price goes lower.