When you buy or sell any option, the strike (or striking) price is a crucial part of the options agreement (contract). 

• The owner of a call option has the right to buy 100 shares of the underlying asset by paying the strike price per share.
   
• The owner of a put option has the right to sell 100 shares of the underlying asset and receiving the strike price per share.

It is important to state one point that may be confusing to the brand new trader: When you BUY THE OPTION, you pay the market price for that option.


That price is the PREMIUM. If you later decide to exercise your rights as the option owner of a call option, then you pay the strike price per share. Do not make the mistake of believing that the premium was a deposit and that you can deduct the original cost of the option when buying shares via an exercise. Similarly, the put owner collects only the strike price (upon exercise)per share, regardless of how much he/she paid for the option.

When you purchase stock, the cost is known immediately.

When you buy an option, you know what the cost pf the stock will be, if and when you decide to exercise your rights. However, most option traders never exercise any options and never own a position in the stock. Instead they sell their options -- thereby earning a trading profit or loss.

 

The Cost of Buying an Option

If you look at any table of option data, it should be clear that the cost (premium) of

• A call option decreases as the strike price increases.
• A put option decreases as the strike price decreases.

The reason why these statements are true is obvious -- once you understand how an option works. Let's look at a typical situation, using call options. You are bullish on stock XYY (trading near $47 per share.) and that you would like to control 100 shares of stock without paying the full cost ($4,700) of stock ownership. You can do that by buying one call option.

For this discussion, let's ignore the expiration date and assume that it is suitable to own calls that expire on the 3rd Friday of July. You may decide to buy one of these call options:

• XYZ  Jul 40 call, giving you the right to buy stock at $40. Option premium: $7.70
• XYZ  Jul 45 call, giving you the right to buy stock at $45. Option premium: $4.05
• XYZ  Jul 50 call, giving you the right to buy stock at $50. Option premium: $0.80

These three options are priced very differently - and that difference is based on the different strike prices. 

It should be easy to understand that the right to buy 100 shares at $40 per share is worth more than the right to buy stock at $45 per share.  Either option gives you the right to buy 100 shares (upon exercise), but it would cost only $4,000 to convert the Jul 40 call option into stock while it would cost $4,500 to do the same with the Jul 45 call. And it would cost $5,000 to exercise the Jul 50 call. 

IMPORTANT: As an option owner, you are never obligated to exercise an option. You cannot be forced to convert that option into stock - UNLESS you still own the option when expiration arrives. If you allow that to happen, and if the option is in the money (i.e., the closing stock price on expiration Friday is above (even by as little as $0.01) the strike price, then the  call option will be automatically exercised for you.Translation: You will buy the shares if you forget to sell your in-the-money option by the time that expiration arrives.