Strike Price Vs Exercise Price: What’s the Difference?

The strike price (also known as the exercise price) is the predetermined price at which you can purchase shares when you exercise your stock options. The value of your options depends on the difference between the strike price and the current fair market value of the stock.

What is the strike price (exercise price)?

The strike price is the fixed price at which an employee can buy company shares through a stock option plan. It is set at the time the options are granted and remains fixed, regardless of future changes in the company’s stock value.

For private companies, the strike price is typically set based on their fair market value (FMV) determined by a valuation process, such as a 409A valuation in the U.S or via a Registered Valuer in India.

This ensures compliance with tax regulations and prevents options from being granted at an artificially low price.

The profitability of stock options depends on how the current market price compares to the strike price. If the stock's value rises above the strike price, employees can exercise their options at a lower price and potentially sell the shares for a profit.

Suppose an employee is granted 100 stock options with a strike price of $10 per share. A few years later, if the company’s stock is valued at $100 per share, the employee can exercise their options and buy shares at $10 each, gaining an immediate paper profit of $90 per share. However, if the stock price drops to $5, there is no financial benefit in exercising them.

How is the strike price of an option determined in India?

For publicly traded companies, the strike price is typically set at the stock's market price on the grant date. For example, if a company's stock is trading at $100 per share on the open market when an employee receives stock options, the strike price will generally be $100. However, sometimes, the company may offer ESOPs at a discount to the prevailing market price

Since private companies' shares are not publicly traded, they need an external valuation to determine the FMV of their stock. In India, this valuation is typically done by a Registered Valuer or a Merchant Banker.

This FMV is often used to set the strike price for ESOPs in private companies.

Regardless of whether a company is public or private, the Companies Act, 2013 allows companies to decide the exercise price, but it must be at least the face value of the shares (the nominal value assigned at issuance, e.g., ₹10 per share).

If ESOPs are granted at a discount to FMV (for private companies) or market price (for public companies), accounting rules (IGAAP) require the discount to be treated as an expense over the vesting period.

In the U.S., however, the strike price must be set at or above the FMV at the time of the grant.

How does the value of stock options change over time?

The value of stock options fluctuates with the company’s performance and market conditions.

If the company grows and its stock price rises, employees with a lower strike price can benefit greatly. However, if the stock price falls below the strike price, the options become “out of the money” and lose their financial advantage.

a. In-the-Money (ITM) stock options: A stock option is considered in the money when the company's stock price is higher than the strike price. For example, if the strike price is $10 and the stock is currently trading at $25, the option holder has a potential gain of $15 per share.

b. Out-of-the-Money (OTM) stock options: A stock option is out of the money when the stock price is lower than the strike price. For example, if the strike price is $10, but the stock is currently worth $7, the option holder would be paying more than the stock’s market value, making it financially unviable to exercise.

Frequently asked questions

1. Is the strike price the same as the exercise price?

Yes, the strike price and exercise price are generally the same. The strike price is the fixed price at which an employee can purchase shares upon exercising their stock options. It is also called the exercise price. ‍

2. How is the strike price determined in India?

In India, the strike price of employee stock options is set by the company and is influenced by the fair market value (FMV) at the time of grant, company policies, and approvals from the board and shareholders.

‍3. What is an example of strike price?‍

An example of a strike price is when a company grants an employee stock options to buy shares at a fixed price of $20 per share. If the company’s stock price rises to $50 per share, the employee can exercise the option and buy the stock at the strike price of $20, potentially making a profit by selling it at the higher market price of $50.

4. What is the difference between strike price and current price?

Strike price is the fixed price at which an employee can buy shares through stock options. While the current price is the present value of a company’s stock, which fluctuates based on market conditions.