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Strike price

From Academic Kids

The strike price, or exercise price, is a key variable in a derivatives contract between two parties. Where the contract requires delivery of the underlying instrument, the trade will be at the strike price, regardless of the spot price (market price) of the underlying at that time. Where settlement is financial, the difference between the strike price and the spot price will determine the value, or "Moneyness", of the contract.

A call option has positive monetary value when the underlying has a spot price (S) above the strike price (K). Since the option will not be exercised unless it is "in-the-money", the payoff for a call option is

Max[ (S-K) ; 0 ] or formally, <math>(S-K)^{+}<math>
where <math>(x)^+ =\{^{x\ if\ x\geq 0}_{0\ otherwise}<math>

A put option has positive monetary value when the underlying has a spot price below the strike price; it is "out-the-money" otherwise, and will not be exercised. The payoff is therefore

Max[ (K-S) ; 0 ] or <math>(K-S)^{+}<math>

For a digital option payoff is <math>1_{S\geq K}<math>, where <math>1_{\{\}}<math> is the indicator function.

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