Defining an Option's "Moneyness"

Quite often you will hear the terms "in-the-money", "at-the-money" and "out-of-the-money" or ITM, ATM and OTM. These terms all refer to an options Intrinsic Value.

The strike price of an option compared to the current stock price is what determines the option's Intrinsic Value and hence determines whether the option is in, at or out of the money. If a call option's strike price is less than the current market price of the underlying asset it is said to be in-the-money - as the option buyer can exercise and make an instant profit.

Consequently, if a calls strike price is higher than the current underlying asset it is said to be out-of-the-money because it has no Intrinsic Value. Confused? Take a look at these quick formulas;

Call Options

In-the-Money = Strike price less than underlying price

At-the-Money = Strike price is the same as the underlying price

Out-of-the-Money = Strike price is greater than the underlying price

Put Options

In-the-Money = Strike price is greater than the underlying price

At-the-Money = Strike price is the same as the underlying price

Out-of-the-Money = Strike price is less than the underlying price

Comments (19)

PeterJune 10th, 2014 at 1:11am

Hi Ray,

I think it is possible - not easily, and not within a short amount of time...so I guess the answer is "no" for a novice ;-) but possible after learning what's needed and after researching and paper trading.

RayJune 9th, 2014 at 1:00pm

Can a novice investor really " make a "living " in the options market?

PeterMarch 31st, 2014 at 6:52pm

Hi Richard,

When you exercise an option you are assigned the value of the strike price - it can be the underlying stock itself or it may simply be a cash settlement amount.

The premium you pay as the buyer of the option is paid to the option seller at the time of the transaction; it isn't factored into the conversion of the option into stock/cash. The is the price you pay to have the "option" to exercise or not and for the seller represents an insurance premium of sorts to take on that risk.

The settlement method depends on the instrument and its specifications. Typically stocks are physically settled (you exercise into the shares) and indicies are cash settled.

Hope this helps - let me know if anything else is unclear.

RichardMarch 28th, 2014 at 9:58am

Question on exercise of european weeklies (SPXW)

Index: SPX
Type: European
Expiration: PM-settled

I know, theoretically, a call (or put) an be exercised at strike but how does it play out in reality with the factored in premium?

e.g. SPX call strike price of 1865. Premium is 3.40. Will the call be exercised at 1865 or 1868.40 (including the premium)? Basically, if the SPX is trading on expiration day around 1865, is it beneficial to sell the 1865 call if the market stays below 1868?

I think that the SPX weeklies have a different type of assignment than a typical stock, correct?

Thanks

PeterFebruary 14th, 2013 at 4:48pm

Hi, no problem with the questions - I'm happy to help!

When the market opens, if you want to exit your position immediately you will sell to the bid price. However, if you're not in a rush to liquidate you can place a sell order for the option at a price above the bid and leave it in the market as a working order.

If your order is sitting on the offer and the market moves up, somebody may buy from you at the ask price.

Yep, you need to subtract your premium and comms to calculate your profit.

For face to face option training, you can reach out to;

Trading Academy

Options University

PoiterFebruary 14th, 2013 at 3:23pm

Thank you for taking your times to answer novice questions. I have a virtual trading account with cboe. I'm currently trading bidu $90 strike call Apr13 at 8.10, 5 contracts. It costs me $4050.

At market close today, bidu closed at 95.23. The chain shows for the 90 call strike, Last: 8.31, Bid: 8.05 and Ask 8.2. Now if I'm going to sell this call tomorrow when market opens, I'd be selling it at 8.05 or whatever the Bid price is, am I correct?

If I'm going to exercise this call, bidu has to hit $99 for me to make a profit. I have to subtract the option premium plus broker's commission.

Is there a good site that you can recommend to trade paper money or virtual money? I live in San Diego and looking for a class that teaches options trading in live person. Do you know of any?

Thanks again.

PeterFebruary 13th, 2013 at 5:50pm

You don't need to exercise the option to realize the profit.

You can sell the call options back in the market, where the price difference will be your profit. If the calls are in the money on the day of expiration you will be able to exit the call at intrinsic value and make your $2,000.

Also, you don't have to call your broker to exercise the options once they have expired - this will be handled automatically. Although, I'm not sure what would happen if you don't have enough funds to hande the exercise - maybe your broker would loan you the money for the position until you exit. I know that Interactive Brokers has the capacity to do this as they margin you a certain amount based on your existing capital.

PoiterFebruary 13th, 2013 at 12:04pm

Hello Peter

I have a couple of novice questions regarding call options. Bidu is currently trading at $96.32. I have $3000 in my account. For discussion purposes, let's say I buy a $100 strike call options expirating in Sept 2013. September rolls around, bidu is trading $120. I want to exercise the options to buy bidu at $100 strike, but I only have $3000 in my trading account. Can I buy the call options and immediately sell the 100 shares at $120? So I would be ITM and this would give me a $2000 profit minus options price minus commission. Do I have to call my broker to execute the trade or can I just leave it alone and let it takes care of itself?

Thanks.

PeterOctober 29th, 2012 at 4:33am

Hi Tan,

1. You don't need to own the stock before shorting a call option.

2. If the option is exercised and you do not own the stock then you will go "short" the stock, which will be delivered to the buyer of the option.

You broker will have to "borrow" stock in order to deliver it to the option buyer and you will pay a stock borrow rate for this service until you buy the stock to cover your short position.

TanOctober 13th, 2012 at 1:51pm

Hi Peter, need your advise in this. Let say:

JPM now is 41.50
I intend to sell a call option at 0.60 with strike price 41.50
At option expiry JPM is 42.00

Question:
1. Do i need to own JPM before i can sell a call option?

2. If i sell a call option at 0.60 and the option was exercised, what will be the implications

Thank you.

PreranaJuly 30th, 2012 at 1:50am

I have read all the comments and its clear to me now....

PeterMay 14th, 2012 at 11:54pm

Yes, your expression is correct. The "moneyness" terms are not dependent on long/short. If the option is out of the money at expiration then it is worthless, whether you're the buyer or the seller. If you're the seller then you have received money for something initially that is now worth zero, so you have profited from the transaction.

MikeMay 14th, 2012 at 12:25pm

do the terms ITM, ATM & OTM always refer to the Buyer of an option? To make myself more clear... if I am selling a Call option with a strike of 100 and the current price of the underlying asset trades at 110... do we say that "I am writing a deep ITM Call option" Would this expression be correct?

PeterJuly 14th, 2011 at 6:00pm

Oh man, I apologize for that! You're right, if you stay in the trade and the stock stays there you will collect the premium of $8 per contract. If the market goes down then you will lose money. You will start losing money if the stock starts going below $127.

Selling the 125's will gain you an extra $1 per contract net but without the downside protection.

JimJuly 14th, 2011 at 11:17am

Hi Peter,
Thanks for getting back to me. your help is greatly appreciated.

You said the trade I asked about was not a good one because it was so close to expiration. What if I'm just looking to collect the premium? My thinking was that because it was so close the possibility of SPY dropping below the strike was negligible and iwould expire worthless.

Also, if it is the premium I'm interested in for right now does it make sense for me to say the heck with the spread and just sell the 125's for .09?

Thanks again

Jim

PeterJuly 14th, 2011 at 2:18am

Hi Jim,

If you are short a put option and the holder exercises, you do not have to do anything - your broker will close out your option position and assign you a position in the stock at the value of the strike price.

For put options, you should first look at the payoff profiles below;

Buy Put Option

Sell Put Option

If you are long a put option you want the market to go down and if short a put option you want the market to either remain at the current level or go up.

The strategy you mention is called a put spread. Given the prices you list, you will receive a credit of $8 to put this trade on ((0.09 - 0.17) * 100)).

The maximum you can gain from this position is going to be the credit you recieved i.e. $8. The maximum loss is going to be $292 (((127 - 124) - 0.08) * 100).

Correct - at expiration if the underlying is trading above 127 both options expire worthless and you keep the $8 premium received.

This trade is not a good one so close to the expiration date given that the stock is trading at $131.50 with 2 days remaining - the stock needs to trade to 124 (+6%)before you can start making any money.

I hope this helps...let me know if anything is not clear.

JimJuly 13th, 2011 at 8:44am

Hi Peter,
I am in the process of trying to learn options. I seem to be getting stuck with long and short puts and I'm hoping you can help.

If I sell a naked put that gets exercised, what is the process...do I just enter a buy to close market order? And regardless... with uncovered puts, whether buying or selling, you still want the stock price to go down and, either way if the strike price is higher than the stock price that Put is ITM, is that right?

Also, can you tell me where the greatest danger (other than the stock taking a sudden nosedive) lies in the following scenario:

SPY currently trading at $131.50
July 11 Puts (2 days to expiration)
BID ASK
124 .07 .09
125 .09 .11
126 .12 .15
127 .17 .20

Buy 10 July15 124 Puts
Sell 10 July15 127 Puts

Assuming on expiration day at 3:00PM if the stock is above 127, both options should expire worthless right?

Thanks in advance for your help

PeterMay 15th, 2011 at 8:18am

Hi Wayne, it depends on the style of the option. If the option is American it can be exercised prior to the expiration date, however, if the option is European it can only be exercised on the expiration date. Most exchange traded options on listed stocks are American.

But this doesn't mean that you can just exercise the option and make a profit by selling the stock as it depends on the price you paid for the option and the price that you sell the stock for.

Let's say you're looking at buying an ITM call option on MSFT with MSFT trading at $25. You look at the $24 call option. Now, the price of this option in the market will never be less than $1, so you will probably end up paying something like $1.10 for the option. If you go and exercise the option, sure, you will be assigned the stock at a price of $24 and then sell the stock for $25 for a $1 profit.

However, you've paid $1.10 for the option, so you have to deduct that from your profit, which in this case leaves a loss of -$0.10.

Let me know if it is still unclear.

WayneMay 14th, 2011 at 9:16am

I haven't seen any action on this board in a few months but I'll pose my question anyway:

Why would you not buy "in the money" call options, exercise the option, sell the underlying asset, and keep the profit? Is there something that says you have to wait until the expiration date to exercise the option?

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