Strike, Premium, Expiration: Reading the Contract

The previous article established the four positions; this one covers the terms that define any individual contract — the strike, the premium, the expiration, and three more that are easy to skip and expensive to skip: the underlying, the contract size, and the settlement method. The structure of this article mirrors the bond pillar's treatment of coupon, face value, and maturity, for the same reason: these are the fields where confusion produces real losses, and each of them is confused with something adjacent.

The three headline terms

Strike price is the price at which the option holder may buy (call) or sell (put) the underlying. It is fixed for the life of the contract, chosen from a set of standardised levels the exchange lists, and it is not a prediction or a target — it is a reference point in a contract. Its relationship to the current price of the underlying determines whether the option has any immediate value, which is the moneyness question the next article takes up. Two practical notes: strikes further from the current price cost less and require a larger move to pay off, so a cheap option is cheap because it is less likely to be worth anything, and choosing a distant strike to reduce the outlay is choosing a lower probability, not a bargain. Premium is what the buyer pays and the writer receives — the market price of the option, set by supply and demand within the bounds pricing models describe. Three things about it. It is quoted per unit of the underlying, so the total paid is the quoted premium multiplied by the contract size, and a premium quoted at $1.50 on a 100-share contract costs $150. It is not refundable if the option is not exercised — the buyer's money is spent on the right, whether or not the right becomes valuable. And it consists of two components, intrinsic and time value, whose separation is the single most useful analytical move in options and the subject of the next article. Expiration is the date the contract ends. After it, the option either has been exercised or has ceased to exist — there is no equivalent of holding a share through a bad year, which is the structural difference that makes options a fundamentally different proposition from the instruments in the preceding pillars. Expiry conventions vary by market and product: monthly cycles are standard, with weekly and in some markets daily expirations also listed, and the precise expiry time and last-trading time are contract terms rather than assumptions. The 0DTE article deals with very short-dated contracts and their distinctive risks.

The three terms people skip

The underlying, specified exactly. Not "Aurelis" but the particular security or index, and for index options this matters because there is no share to deliver. Adjustments also occur: splits, special dividends, mergers, and other corporate actions cause contract terms to be adjusted by the clearing house, sometimes producing non-standard strikes and deliverables that surprise holders. Contract size and multiplier. Equity options conventionally cover 100 shares per contract, so every quoted figure must be multiplied — the most common arithmetic error made by newcomers, and one that works in both directions: a premium that looks like $1.50 is $150, and a loss that looks like $3 per share is $300 per contract. Index options use a stated multiplier rather than a share count, and non-standard contract sizes exist. Getting this wrong means being wrong about the size of the position by two orders of magnitude. And settlement method. Some options settle by physical delivery — actual shares change hands on exercise — and some settle in cash, with the difference paid rather than the underlying delivered. Index options are typically cash-settled; single-stock options are typically physically settled. This determines what actually happens to you at exercise, including whether you need funds or shares available, and the assignment article covers the consequences. Two further specification points worth knowing. Exercise style — whether the option can be exercised before expiry or only at it — is a contract term with real consequences, covered in its own article. And the option chain is how these terms are presented in practice: a grid of available strikes and expirations with their premiums, which is legible once you know that every cell is a distinct contract with its own terms rather than a variant of one instrument.

How the terms interact — and the trap in cheapness

Three relationships explain most of what a reader will observe. Premium rises with time to expiry, other things equal, because more time means more opportunity for the underlying to move favourably — and it follows that premium falls as expiry approaches, which is the decay the next article quantifies. Premium rises as the strike becomes more favourable to the holder — a call with a lower strike costs more than one with a higher strike, because the right it confers is worth more. And premium rises with expected volatility in the underlying, because a more volatile underlying is more likely to make a large move in either direction, which is the implied-volatility subject. Now the trap, stated plainly because it is where inexperienced buyers lose money most reliably. A cheap option is cheap for reasons, and all of them reduce your probability of gain. The premium is low because the strike is far from the current price, or because little time remains, or both — and each of those is the market pricing a low likelihood that the option finishes with value. Buying a very cheap, far-out-of-the-money, near-expiry option gives a large notional exposure for a small outlay, and it is also the configuration most likely to expire worthless. The low price is not an inefficiency; it is information. This portal describes that arithmetic rather than telling anyone what to do with it, and notes that the appeal of a small outlay controlling a large exposure is precisely the appeal that the behavioural literature associates with lottery-like payoff structures.