To better understand strike prices, let's compare options to futures contracts. In a futures contract, the buyer and seller agree on a price for the underlying stock to be traded on a future date. In contrast, options contracts have fixed prices set by the exchange, known as strike prices. These strike prices can vary, with multiple option contracts available at different strike prices.

For example, if Infosys is currently trading at Rs. 1000 (spot price), the December options could have strike prices of Rs. 940, Rs. 960, Rs. 980, Rs. 1000, Rs. 1020, Rs. 1040, and so on. Typically, there are four or five strike prices on either side of the spot price, providing various options for buyers and sellers.

The buyer and seller can select any strike price, allowing the option holder to buy or sell the underlying asset at the chosen price until the expiry date. For instance, a December Call option for Infosys with a strike price of Rs. 1040 enables the holder to buy Infosys shares at Rs. 1040 regardless of the current market price.

The strike price is determined by three key factors:

1. Time remaining until contract expiry

2. Volatility of the underlying stock

3. Current interest rates

Once set, the strike price remains unchanged, unaffected by fluctuations in the market price. The difference between strike prices can vary depending on the asset type and market conditions.

WHY STRIKE PRICES? 

Strike prices are essential in options trading because they provide a fixed price at which the underlying asset can be bought or sold. Without strike prices, options wouldn't have a fixed price, defeating their purpose.

Having multiple strike prices ensures liquidity in the options market. If there were only one strike price, it would eventually become worthless for either the buyer or seller, reducing market participation.

Unlike futures, options don't have marked-to-market pricing, where the strike price would change daily based on the underlying asset's spot price. This allows hedgers to maintain the right to buy or sell at a fixed price, providing a valuable risk management tool.

Why is strike price important? 

The strike price is important because it determines the moneyness of an option contract, which refers to the profitability of the contract with the spot price and strike price of the underlying shares. The strike price helps to classify options into three categories:

• In the money (ITM): The option is profitable because the strike price is more favorable than the spot price.

• Out of the money (OTM): The option is unprofitable because the strike price is less favorable than the spot price.

• At the money (ATM): The strike price is equal to the spot price, making the option neither profitable nor unprofitable.

The strike price plays a crucial role in assessing the value and potential of an option contract, making it a vital component of options trading.