---
title: "Strike Price (Exercise Price): What It Is, How It's Set, and Why It Matters"
slug: strike-price
publishedAt: 2026-04-04T11:27:28.610Z
updatedAt: 2026-06-26T15:54:54.660Z
author: "Mike Navarro"
authorSlug: mike-navarro
category: "Stock Options"
tags: ["Stock Options", "ISO", "NSO", "Glossary"]
excerpt: "Your strike price determines your profit when exercising stock options. Learn how companies set it, the role of 409A valuations, what happens when options go underwater, and the tax implications."
canonical: https://myequitytax.com/blog/strike-price
---
Your strike price (the exercise price) is the fixed price you pay to buy shares when you exercise stock options. It is set at your grant and stays the same for the life of the option. The gap between the stock's fair market value at exercise and your strike price is your taxable spread.
This difference between the **fair market value** (FMV) of the stock when you exercise and your **strike price** (also called the **exercise price**) is what the IRS calls the **spread** or **bargain element**. The lower your strike price relative to the current FMV, the more valuable your options are.
## How Strike Price Is Set
The method for determining strike price differs depending on whether your company is public or private.
### Public Companies
For publicly traded companies, the strike price is typically the **closing market price** of the stock on the date of your option grant. Since there is a readily available market price, setting the strike price is straightforward.
For example, if the stock closes at $150 on your grant date, your strike price is $150.
### Private Companies: 409A Valuations
Private companies do not have a public market price, so they must determine FMV through an independent appraisal called a **409A valuation** (named after IRC Section 409A). Key points:
- Performed by an independent third-party valuation firm
- Updated at least annually, or after material events (new funding round, major revenue changes)
- The 409A value is almost always lower than the preferred share price from the latest funding round (because common stock has fewer rights than preferred stock)
- If options are granted below the 409A FMV, there are severe IRC Section 409A penalties (20% additional tax + interest)
**Why your strike price is lower than the "company valuation" you read about.** When a startup raises a Series B at a $500M valuation, that values the *preferred* shares. The 409A valuation for common stock (what your options are for) typically applies a discount of 20-40% for lack of marketability and minority interest. This is why your strike price may be $3/share when headlines say the company is worth $50/share.
## How 409A Valuations Change Over Time
A company's 409A valuation rises as the business matures, which means employees hired at different stages receive dramatically different strike prices. This is one of the most significant factors in startup equity compensation — early employees take more risk but get a much larger potential payoff.
The chart below illustrates how a private company's fair market value tends to climb across funding stages, which is the same trajectory that drives strike prices higher for later hires.
Here is a hypothetical startup's 409A progression through funding rounds, assuming an eventual exit at $100/share:
| Stage | 409A Valuation | Strike Price | Spread at $100 Exit |
|-------|---------------|-------------|-------------------|
| Seed | $0.50 | $0.50 | $99.50/share |
| Series A | $2.00 | $2.00 | $98.00/share |
| Series B | $8.00 | $8.00 | $92.00/share |
| Series C | $25.00 | $25.00 | $75.00/share |
| Late-stage / Pre-IPO | $60.00 | $60.00 | $40.00/share |
The difference in outcomes is striking. A seed-stage employee with 10,000 options would realize a spread of $99.50 x 10,000 = **$995,000** at the same $100 exit where a late-stage employee with 10,000 options would realize only $40.00 x 10,000 = **$400,000**. Both hold the same number of options on the same stock, but the seed employee's lower strike price produces nearly 2.5x the profit.
This is also why 409A valuations matter for tax planning. The seed employee faces a much larger spread — and therefore a much larger AMT exposure if holding ISOs — than the late-stage hire. A $995,000 spread could trigger over $150,000 in AMT, while a $400,000 spread triggers roughly $60,000. The timing of when you joined the company fundamentally shapes your tax planning strategy.
Companies typically update their 409A valuation after each funding round, before granting a meaningful number of new options, or at least once per year — whichever comes first. If you are considering joining a startup, ask when the last 409A was performed and whether a new round is imminent. A funding round that closes the week after your start date could mean the next batch of options is priced significantly higher.
## Strike Price and Your Exercise Decision
Your exercise decision should be heavily informed by the size of your spread — the gap between your strike price and the current FMV. The chart below compares how different exercise strategies play out once you factor in the spread and the resulting tax.
Here is a practical framework:
- **Small spread (less than $5/share):** Exercise early. The tax cost is minimal, and you start your long-term capital gains holding period clock immediately. For ISOs, the AMT impact of a small spread is often absorbed by the exemption.
- **Moderate spread ($5-$25/share):** Model the AMT before committing. Use the AMT-free exercise limit to determine how many shares you can exercise without triggering additional tax. Partial exercises across multiple years often make sense at this spread level.
- **Large spread (over $25/share):** Proceed with caution. Consider partial exercise across 2-3 tax years to spread the AMT exposure, or a same-day sale (disqualifying disposition) for NSOs to lock in the gain without holding risk. For ISOs, the AMT bill on a large spread can be five or six figures.
**Not sure where you fall?** Our [ISO AMT calculator](/calculator/iso) calculates your exact AMT-free exercise limit based on your salary, filing status, and state. For a broader overview of tax planning around stock options, see our [stock options tax calculator](/blog/stock-options-tax-calculator) guide.
## The Spread: Why Strike Price Matters
The **spread** (or bargain element) = FMV at exercise - Strike price.
**Worked Example:**
| Item | Value |
|------|-------|
| Strike price (set at grant) | $2/share |
| FMV at exercise | $20/share |
| **Spread** | **$18/share** |
| Shares exercised | 10,000 |
| **Total spread** | **$180,000** |
| Cost to exercise | $20,000 (10,000 x $2) |
| Value of shares received | $200,000 (10,000 x $20) |
In this example, you pay $20,000 to receive $200,000 worth of stock — a $180,000 gain. But how that $180,000 is taxed depends on whether you hold ISOs or NSOs.
## How Strike Price Affects ISO vs NSO Taxes
The tax treatment of the spread differs significantly between Incentive Stock Options (ISOs) and Non-Qualified Stock Options (NSOs), as outlined in the [IRS guidance on stock options (Topic 427)](https://www.irs.gov/taxtopics/tc427):
| Tax Event | ISO | NSO |
|-----------|-----|-----|
| At exercise (regular tax) | No tax on spread | Ordinary income tax on spread |
| At exercise (AMT) | Spread is AMT preference item | No AMT adjustment (already taxed) |
| At sale (qualifying) | Entire gain taxed as LTCG | Gain above FMV at exercise taxed as LTCG |
| At sale (disqualifying) | Spread taxed as ordinary income | N/A (already taxed at exercise) |
### ISO Example (Strike $2, Exercise at FMV $20)
- **At exercise:** No regular tax, but $18/share spread is an AMT preference item reported on [Form 6251](https://www.irs.gov/forms-pubs/about-form-6251)
- **If held 1yr from exercise + 2yr from grant:** Entire gain from $2 to sale price is long-term capital gain
- **If sold early (disqualifying):** Spread taxed as ordinary income — but no AMT
### NSO Example (Strike $2, Exercise at FMV $20)
- **At exercise:** $18/share spread is immediately taxed as ordinary income (on your W-2), consistent with how the [IRS treats equity compensation in Publication 525](https://www.irs.gov/publications/p525)
- **At sale:** Only the appreciation above $20 (FMV at exercise) is a capital gain
For a deep dive into ISO exercise planning and AMT exposure, see our [ISO AMT calculator guide](/blog/amt-calculator-stock-options) or use our [stock options tax calculator](/blog/stock-options-tax-calculator).
## Underwater Options
Options are **underwater** (also called "out of the money") when the current FMV is lower than your strike price. In this case, exercising would mean paying more for the shares than they are currently worth.
**Example:** Strike price $20, current FMV $12. The spread is negative (-$8). Exercising would cost you $20/share for stock worth $12/share.
**What to do with underwater options:**
1. **Wait.** If the stock price recovers above your strike price before your options expire, they become valuable again.
2. **Let them expire.** If your options are expiring and the stock is still below your strike price, they are worthless — but you have no tax liability.
3. **Check for repricing.** Some companies reprice underwater options to a lower strike price to retain employees (more common at private companies).
**ISO underwater trap with AMT.** If you exercised ISOs when the FMV was high (generating AMT) and the stock later dropped below your strike price, you may have paid AMT on a spread that no longer exists. The AMT credit carryforward can help, but the cash impact is painful. This is why timing your ISO exercises is critical — plan with our [exercise timing guide](/blog/when-to-exercise-stock-options).
## Option Repricing
When a company's stock price drops significantly, outstanding options may be underwater for most employees. Companies sometimes address this by:
1. **Repricing:** Lowering the strike price of existing options to the current FMV
2. **Exchange programs:** Canceling underwater options and issuing new ones at the current FMV (often with a new vesting schedule)
3. **Cash settlements:** Buying back underwater options for a token amount
Repricing has accounting and tax implications for both the company and employees. If your company announces a repricing or exchange program, review the terms carefully — the new vesting schedule may reset your clock.
## Underwater Options and Repricing: Tax Implications
When the FMV drops below your strike price, your options have zero intrinsic value — the spread is negative. You would not exercise because you would be paying more per share than the stock is currently worth. In this situation, the options are purely speculative: they only have value if the stock price recovers above your strike price before the options expire (typically 10 years from grant for ISOs).
**Recovery strategy:** Simply wait. If the company's fundamentals are sound and the stock recovers above your strike price, you can exercise at that point. The spread will be smaller than it would have been at the peak, but the options will have value again.
**Company repricing:** During market downturns, some companies reduce the strike price on existing option grants to retain employees. Repricing requires board approval and, for public companies, typically requires shareholder approval as well. There are important tax implications to be aware of: repricing an ISO can create a new measurement date, which resets the $100K annual ISO limit calculation and may restart the two-year holding period requirement for qualifying disposition treatment. Additionally, if the repricing is not structured correctly, it can trigger IRC Section 409A penalties — a 20% additional tax plus interest on the deferred compensation. Always consult your company's equity plan administrator and a tax advisor before participating in a repricing program.
## Strike Price vs Grant Price vs Exercise Price
These terms cause frequent confusion, but they are mostly synonymous in practice — with one subtle distinction:
- **Strike price:** The price specified in your stock option grant agreement. For ISOs and NSOs granted in compliance with Section 409A, the strike price is set at fair market value on the grant date.
- **Exercise price:** The price you actually pay per share to buy stock when you exercise your options. For standard stock options, the exercise price always equals the strike price. They are the same number.
- **Grant price:** An informal term sometimes used to mean the strike price. However, it can also refer to the FMV on the date the grant was approved by the board, which may differ slightly from the official grant date (the date the grant is formally documented and communicated to you). This distinction matters because the official grant date determines the strike price for 409A purposes.
For ISOs and NSOs, strike price = exercise price in virtually all cases. The term "grant price" is the ambiguous one — if you encounter it in company communications or offer letters, confirm whether it refers to the strike price in your option agreement or the FMV on some other date. The legally binding number is always the one in your option grant agreement.
## Strike Price and the $100K ISO Annual Limit
ISOs have a special rule: the aggregate FMV of shares (at the **grant date**, using the strike price as a proxy for FMV at grant) that become exercisable for the first time in any calendar year cannot exceed $100,000. Options above this limit are automatically treated as NSOs.
**Example:** You receive 50,000 ISOs with a strike price of $3/share, vesting 25% per year.
- Year 1: 12,500 shares become exercisable. FMV at grant = 12,500 x $3 = $37,500. Under $100K limit. All ISOs.
- If strike price were $10: 12,500 x $10 = $125,000. Exceeds $100K. The first 10,000 shares ($100K) are ISOs; the remaining 2,500 are NSOs.
## Frequently Asked Questions
**What determines my strike price?**
For public companies, it is the stock's market price on your grant date. For private companies, it is the FMV determined by an independent 409A valuation. Your strike price is locked in at the time of grant and does not change.
**Can my strike price change after the grant?**
No, not under normal circumstances. Your strike price is fixed at grant. However, some companies offer repricing programs for underwater options, which effectively give you new options with a lower strike price (usually with a new vesting schedule).
**Is a lower strike price always better?**
Yes, from a pure value perspective — a lower strike price means a larger potential spread and more profit. However, a lower strike price also means a larger AMT exposure if you hold ISOs, because the AMT preference item is based on the spread at exercise.
**What happens if I exercise when the stock is at my strike price?**
The spread is zero, so there is no income to report, no tax consequence, and no AMT impact. You simply pay the strike price to acquire shares. This is sometimes called exercising "at the money." It is a common strategy for early employees at private companies who want to start their long-term capital gains holding period early. See our guide on [when to exercise stock options](/blog/when-to-exercise-stock-options).
**How does the 409A valuation affect my taxes?**
The 409A valuation at grant determines your strike price. A lower 409A means a lower strike price, which means a larger spread (and more tax) when you eventually exercise. The 409A at the time of exercise determines the FMV for calculating the spread for tax purposes.