One of the basic concepts of trading options is the “strike price” of the option. For call options, the strike price is the price at which you have the right to buy the asset before expiration, and for put options the strike price represents the price at which you have the right to sell the asset at expiration.
As the price of the asset changes in relationship to the strike price, the option is said to be “Out of the Money” (OTM), “At the Money” (ATM) or “In the Money” (ITM).
Out of the Money – When the strike price is above the current asset price for call options or when the strike price is below the asset price for put options. In these cases, the option has no value other than time value. In other words, there would be no point in exercising the call at a price higher than the current market price.
For example, if IBM is trading at $200 a call option with a strike of 205, 210 or higher is said to be “out of the money”. Since call options give you the right to buy the asset at the strike price of the option, having the right to buy IBM at 205 when it is trading at $200 doesn’t have any value other than the possibility that IBM goes up 205 before expiration.
For put options the 195 or 190 puts would also be out of the money, since put options give you the right to sell the asset at the strike price. Again, if IBM is selling for $200, why would you sell it at a lower price? So those OTM strike prices only carry time value (which is also known as “extrinsic value”).
At the Money – An option contract is at the money when the strike price is equal to the price of the stock. In this situation, the option contract only has time value, because there is no reason to exercise your option. If IBM is trading at $200 then the call and put strike of 200 would be considered at the money.
But what if IBM is trading at 201 or 202? Most options traders will loosely refer to an option as “at the money” if the option, whether call or put, is the nearest strike to the market price. The strike price doesn’t have to be exactly at the exact market price to be considered at the money.
In the Money – An option contract is in the money when the strike price is below the price of the asset for a call option and higher than the price of the asset for a put option. It is in the money because now it has real value or (intrinsic) value. Now, if you exercise your option rights, there is real value in the option and you would receive economic value from the exercise of the option.
Options that are in the money also will have some time value as well. Continuing to use our IBM example at a price of $200, a call strikes at 195 and 190 or lower would be considered in the money. They have real value since each of these strikes allow you to buy IBM below the current price. So the 195 strike has a real value of at least $5 while the $190 strike has a real value of at least $10. We say they have at least $5 and $10 value because there will most likely be additional time value in the price of the options making their prices higher.
For puts, strike prices of 205 and 210 or higher are also considered in the money. These strikes allow you to sell IBM at a higher price than the price that IBM is currently trading at, which means they have real value built into them.
Some other characteristics:
OTM – The further OTM, the lower the price of the option. OTM options expire worthless at expiration as time value goes to zero.
ATM – These options have the most time value of all of the options. However, the price is still 100% extrinsic and thus will go to zero at expiration if the underlying asset is trading exactly the strike price.
ITM – These options have the highest price due to the fact that they carry intrinsic value and time value. If you hold them until expiration the option’s value will fall to the amount of any intrinsic value as the time value will go to zero. So a call ITM option with a strike of 190 with IBM trading at $200 would be worth $10 at expiration.
Seth Freudberg,
Director, SMB Options Training Program
No Relevant Positions
