What is an Exercise Price?

An exercise price is the price at which the holder of an option can purchase or sell the security associated with the option. The exercise price is determined when the option is originally written. If the instrument is a call option, the exercise price is the price paid by the option holder to the option writer. If the instrument is a put option, the exercise price is the price paid by the option writer to the option holder. For the option holder to earn a profit by exercising a call option, the exercise price must be lower than the current market price, so that the person can buy the stock and then immediately sell it on the open market. The reverse is the case for a put option.

Example of Exercise Price

As an example of the exercise price, Elliott owns an option to buy 1,000 shares of the common stock of Acme Corporation at a price of $12. The current market price of Acme stock is $15, so it makes sense to exercise the options at the exercise price of $12 and immediately sell the shares at the current market price of $15. Doing so results in a profit of $3,000. Elliott could also buy and hold the shares, though this presents the risk that he could lose the initial profit if the market price of the shares subsequently declines.