6 Quick Examples To Mastering Option Moneyness (ITM, OTM & ATM)

option moneyness

You have probably heard the following terms: in-the-money, at-the-money, and out-of-the-money.

These terms refer to moneyness, which is an important aspect to understand if you are entering the world of options trading. In this article, we’ll discuss the basic concepts of option moneyness.

What is Option Moneyness?

Moneyness refers to how the strike price of the option relates to the current trading price of the underlying asset.

In other words, moneyness describes the extrinsic value of an option in its current state. 

Options are classified by traders into three very distinct categories based on the relationship of the strike price to the underlying stock price at the current time. The categories describe an option’s moneyness.

It’s important to get a handle on these categories and what they mean before you even think about starting to trade options. Every option strategy will incorporate these terms and without a solid understanding, beginners can easily find themselves confused.

The three types of option moneyness are:

  •  In-The-Money (ITM)
  •  Out-of-The-Money (OTM)
  •  At-The-Money (ATM)

We have created a helpful, quick Video Tutorial on Option Moneyness that can be found on our website. Watching this video will provide extra help in getting a handle on these concepts.

Moneyness in single options contracts is a fundamental concept to master when trading options. Moneyness does get more complicated once you start to add sophisticated options strategies to the mix, so it’s important to take the time early on to establish a good solid basic understanding.

The Three Categories

Each of the three categories is driven by the relationship between the current stock price and option strike price.

In-The-Money (ITM)

ITM does not mean that the trader is going to make a profit necessarily but instead describes the position of the strike price against the stock price at any given time.

For example, if you have a call option and your stock price is greater than the current strike price, that option is said to be in-the-money. It’s just describing the relationship between the two prices and not the trader’s actual profitability. If you have a put option and the stock price is lower than the strike price, then your position is in-the-money (see example charts below).

 

Out-Of-The-Money (OTM)

Again, OTM doesn’t mean the trader has lost money on a trade but is simply a generic description of where the strike and stock prices are in relation to each other, for your particular trade, at present.

For a position to be considered OTM, with a call option, the stock price would need to be lower than the strike price, and for a put option, the stock price would need to be higher than the strike price.

At-The-Money (ATM)

Options are ATM when both prices are at the same level and are no different whether you are trading in calls or puts. It shows a parity of price levels across stock and strike prices.

Determining The Value of the Option

An option’s pricing is based on two components:

  • intrinsic value
  • extrinsic value

Intrinsic Value

Intrinsic value is the value of an option if it expired at this very moment.

  • When traders say an option is in-the-money, they are saying it has intrinsic value.
  • When they say it is out-of-the-money, the option has no intrinsic value.
  • When traders say that the contract has expired worthless, it’s because an option expired while out-of-the-money.

The relationships between ITM, OTM, and ATM are all used to help determine the intrinsic value of the option, which is a key factor in option pricing overall.

It is important to look at the trade you are making and ask this question:

  • If this option were to expire today, would it have any value?
  • If yes, then the option has intrinsic value.

Remember: out-of-the-money options have no intrinsic value and expire worthless.

Extrinsic Value

Although extrinsic value plays a less prominent part in moneyness, it is an important concept to understand when trading options.

Extrinsic value has several components. Time value, or theta, is the portion of an option’s premium that is attributable to the amount of time remaining until the expiration of the option contract. Although not the only component, time value is the component that receives the most attention.

As with most things, time is money. In this case, time is value. 

Typically, the more time that remains until expiration, the higher the extrinsic value of the option. Investors will pay a higher premium for additional time since the contract will have longer to achieve profitability from a favorable move in the underlying asset. 

And the reverse is true. When there is less time remaining until expiration, investors are less willing to pay a premium, because the stock has less time to become profitable.

Option Moneyness Examples:

In-The-Money

In this example, we have a $40 strike call option.

The option is ITM if the stock price is higher than $40 because you can buy the stock for $40 when it is trading at $50.

So, the y-axis shows profits when the stock price rises above $40 and a loss when the stock price is below $40.

For a call option, the option will be deemed to be in-the-money if the strike price is below the current value of the stock trading in the market.

Call ITM

However, for a put option, the reverse is true – the option will be in-the-money if the strike price is above the current value of the stock trading in the market.

In this example, we now have a $40 strike put option.

The option is ITM if the stock price is lower than $40 because you can sell the stock for $40 when it is trading at $30.

So, the y-axis shows profits when the stock price falls below $40 and a loss when the stock price is above $40.

Put ITM

Out-Of-The-Money

To discuss OTM options, we’re simply going to reverse our ITM logic.

In this example, we have a $40 strike call option.

The option is OTM if the stock price is lower than $40 because you can buy the stock for $40. But why would you if it’s trading for less than that?

So, for a long call option, the option would be considered to be out-of-the-money if the strike price is above the current value of the stock trading in the market.Call OTM

Again, for a long put option, it’s the opposite stance, so the option would be out-of-the-money if the strike price is below the current value of the stock trading in the market.

In this example, we again have a $40 strike put option.

The option is OTM if the stock price is higher than $40 because your put option only entitles you to sell the stock for $40. But if it’s trading at $50, why would you use the option? You wouldn’t. So the option is OTM.Put OTM

At-The-Money

Options are said to be ATM when the strike price and the

 stock price are the same so this applies to both long calls and long puts.Call ATM

It is rare to have options with the same strike price as the stock price, so most options traders consider anything within a couple of points to be ATM. It’s essentially the “tipping point” between an option being OTM and ITM.Put ATM

What About Short Options?

Short option contracts are just the mirror image of the above long contract payoff diagrams. Most of the option moneyness examples we have here would be the reverse for short option contracts.

How Should Moneyness Play Into My Trading Strategy?

When options are ITM, they represent profitable opportunities for traders. For example, buying a call option that is significantly ITM presents the same profit opportunity in terms of dollars as purchasing the actual stock, but you can trade with much less capital investment. This can result in a higher return.

Selling call options that are deep ITM presents the opportunity to take some profit immediately, rather than waiting until the underlying stock is sold.

Learn More

If you are interested in learning more about trading with short options, watch these two tutorials on Short Calls and Short Puts from our video tutorial library.

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The Answer Vault

The questions on your mind are likely also on the minds of other investors. Check out the Answer Vault on our website: https://optionalpha.com/members/answer-vault.

  • We have listened to the most common questions asked by our members and compiled the responses to create an extended Frequently Asked Questions section.
  • Answers about moneyness and everything else you need to know about options trading are in the vault!
  • And as always, please add your comments and suggestions below!
About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.