In the Money vs. Out of the Money: An Overview
In options trading, the difference between "in the money" (ITM) and "out of the money" (OTM) is a matter of the strike price's position relative to the market value of the underlying stock, called its moneyness.
An ITMoption is one with a strike price that has already been surpassed by the current stock price. An OTMoption is one that has a strike price that the underlying security has yet to reach, meaning the option has nointrinsic value.
Key Takeaways
- In options trading, the difference between "in the money" (ITM) and "out of the money" (OTM) is a matter of the strike price's position relative to the market value of the underlying stock, called its moneyness.
- Because ITM options have intrinsic value and are priced higher thanOTM options in the same chain, and can be immediately exercised.
- OTM are nearly always less costly than ITM options, which makes them more desirable to traders with smaller amounts of capital.
- OTM options are more commonly traded for strategies such as covered calls or protective puts.
In the Money
ITM options have their uses. For example, a trader may want to hedge or partially hedge their position. They may also want to buy an option that has some intrinsic value, and not just time value. Because ITM options have intrinsic value and are priced higher thanOTM options in the same chain, theprice moves (%) are relatively smaller. That is not to say ITM option won't have large price moves, they can and do, but, compared to OTM options, the percentage moves are smaller.
Certain strategies call for ITM options, while others call for OTM options, and sometimes both. One is not better than another; it just comes down to what works for the best for the strategy in question.
Calls
A call option gives the option buyer the right to buy shares at the strike price if it is beneficial to do so. An in the money call option, therefore, is one that has a strike price lower than the current stock price. A call option with a strike price of $132.50, for example, would be considered ITM if the underlying stock is valued at $135 per share because the strike price has already been exceeded. A call option with a strike price above $135 would be considered OTM because the stock has not yet reached this level.
In the case of the stock trading at $135, and the option strike of $132.50, the option would have $2.50 worth of intrinsic value, but the option may cost $5 to buy. It costs $5 because there is $2.50 of intrinsic value and the rest of the option cost, called the premium, is composed of time value. You pay more for time valuethe further the option is from expiry because of the greater probability the underlying stock price will move before expiry, which provides an opportunity to the option buyer and risk to the option writer which they need to be compensated for.
Puts
Put options are purchased by traders who believe the stock price will go down. ITM put options, therefore, are those that have strike prices above the current stock price. A put option with a strike price of $75 is considered in the money if the underlying stock is valued at $72 because the stock price has already moved below the strike. That same put option would be out of the money if the underlying stock is trading at $80.
Generally, the price of a put option increases the farther away from expiry it is, because of the time value issue discussed above.
Out of the Money
In the money or out of the money options both have their pros and cons. One is not better than the other. Rather,the variousstrike pricesin an options chain accommodate all types oftradersand option strategies.
When it comes to buying options that are ITM or OTM, the choice depends on your outlook for theunderlying security, financial situation, and what you are trying to achieve.
OTM options are less expensive than ITM options, which in turn makes them more desirable to traderswith little capital. Although, trading on a shoe-string budget is not advised. Some of the uses for OTM options include buying the options if you expect a big move in the stock. Since OTM options have a lower up-front cost (no intrinsic value) than ITM options,buying an OTM option is a reasonable choice. If a stock currently trades at $100, you can buy an OTM call option with a strike of $102.50 if they think the stock will reasonably rise well above $102.50.
OTM options often experience larger percent gains/losses than ITM options. Since the OTM options have a lower price, a small change in their price can translate intolarge percent returns and volatility. For example, it is not uncommon to see the price of an OTMcall optionbounce from $0.10 to $0.15 during a single trading day, which is equivalent to a 50 percent price change.
FAQs
In-the-money call options have a strike price that is lower than the current market price of the underlying asset, while out-of-the-money call options have a strike price that is higher than the current market price.
What is the difference between in the money and out the money? ›
Calls are in the money when the security's price is above the strike price, and out of the money when the security's price is below the strike price. Put options are in the money when the security's price is below the strike price, and out of the money when the security's price is above the strike price.
What is the difference between ITM and OTM? ›
Key Takeaways
A call option is in the money (ITM) if the market price is above the strike price. A put option is in the money if the market price is below the strike price. An option can also be out of the money (OTM) or at the money (ATM).
What is the difference between in the money and out of the money mortgage? ›
The terms refer to the relationship between the options strike price and the market value of the underlying asset. “In the money” refers to options that have profit potential if exercised today, while “out of the money” refers to those that do not.
Which is good in the money or out of the money? ›
Out-of-the-money options perform better with a substantial increase in the price of the underlying stock; however, if you expect a smaller increase, at-the-money or in-the-money options are your best choices. Bullish investors must have a good idea of when the stock will hit their target price—the time horizon.
What is an example of in-the-money and out of the money? ›
If the intrinsic value is a non zero number, then the option strike is considered 'In the money'. If the intrinsic value is a zero the option strike is called 'Out of the money'. The strike, which is closest to the Spot price, is called 'At the money'.
What is in and out money? ›
In and out refers to buying a stock, currency or other financial instrument (going into the market) and selling it quickly (getting out of the market). The process is repeated multiple times over a short period. It is predominantly used by day traders who are less interested in long-term growth.
What is an example of an out of the money option? ›
In another scenario, if a stock is trading at Rs. 70, and an investor has a put option with a strike price of Rs. 60. Here, the market price being higher than the strike price renders this put option OTM.
Why are OTM puts more expensive than OTM calls? ›
Puts (options to sell at a set price) generally command higher prices than calls (options to buy at a set price). One driver of the difference in price results from volatility skew, the difference between implied volatility for out-of-the-money, in-the-money, and at-the-money options.
Is ATM ITM or OTM? ›
Out of the money option
Here, the logic is exactly opposite to that of an ITM options contract. An option is referred to as OTM only when the strike price of the options contract is unfavourable to the underlying asset's price. In such a scenario, an options contract will not have any intrinsic value.
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What is the meaning of OTM? ›
Out of the money (OTM) is one of three terms used to address an option's 'moneyness', with the other two being at the money and in the money. An out of the money options contract has not yet reached the value of its strike price, meaning it has no intrinsic value and will expire worthless.
What are the benefits of OTM options? ›
Because OTM options have such low premiums they can also provide the trader with a significant amount of leverage because you can control large positions for a small premium. However, it is also true that an OTM option is less sensitive to price moves than the ITM or ATM option.
What is the meaning of ITM? ›
4 min. The term “In the Money” (ITM), when applied to options, refers to an option that has an intrinsic value. Thus the option has a value as the strike price is favourable when compared with the current market price of the underlying asset.
What is the difference between in-the-money and out of the money Delta? ›
If an options delta is less than 50 it is said to be out of the-money. If the delta is greater than 50 the option is said to be in-the-money. If the delta is equal or close to 50 the option is said to be at-the-money.
Is it better to buy ITM or OTM options? ›
OTM options provide more upside leverage if you expect a larger move. The lower premium cost leaves more room for the Option to increase in value. But if you anticipate a smaller directional move, ITM options have a higher likelihood of earning a profit. Paying an extra premium provides more downside protection.
What is an in-the-money put option? ›
What Is an "In the Money" Put Option? A put option is considered in the money when the price of the underlying asset is lower than the strike price at the expiration date.
What happens if your options expire in-the-money? ›
If an option expires in-the-money, it will be automatically converted to long or short shares of stock in the associated underlying.
