Out-of-the-Money (OTM) refers to an option that currently has no intrinsic value because the underlying asset's market price is less favorable than the option's strike price.
Out-of-the-Money (OTM) is a term used in options trading to describe the status of an option contract that would not be profitable if exercised immediately. For call options, an option is out-of-the-money when the strike price is higher than the current market price of the underlying asset, meaning exercising the option would cost more than buying the asset directly. For put options, it is out-of-the-money when the strike price is lower than the market price of the underlying asset, so the option holder would forfeit potential gain by exercising it.
The concept of Out-of-the-Money matters significantly in formulating investment strategies involving options as it indicates the potential profitability and risk exposure of option positions. OTM options typically cost less, offering a leveraged approach for gaining exposure to underlying assets with limited downside – the premium paid. This is particularly relevant for wealth managers and family offices seeking to manage risk efficiently, employ strategic hedging, or pursue asymmetric risk-reward profiles.
Consider a call option on a stock with a strike price of $100, while the current stock price is $90. Since the strike price exceeds the stock price, this call option is out-of-the-money. Exercising the option would cost $100 per share to buy stock worth only $90, which is not economically rational. However, the option may still hold time value if there is remaining time until expiration.
In-The-Money
In-The-Money (ITM) options have intrinsic value because the underlying asset's price is favorable relative to the option's strike price. For call options, ITM means the strike price is below the market price; for put options, it means the strike price is above the market price, indicating immediate exercise would be profitable.
What does Out-of-the-Money mean for call and put options?
For a call option, Out-of-the-Money means the strike price is higher than the current market price of the underlying asset. For a put option, it means the strike price is lower than the current market price. In both cases, exercising the option immediately would not be profitable.
Can Out-of-the-Money options still have value?
Yes, Out-of-the-Money options do not have intrinsic value but can have time value, which reflects the possibility of the option becoming profitable before expiration. Therefore, they can still be traded and have a premium.
Why would an investor buy Out-of-the-Money options?
Investors buy Out-of-the-Money options because they are cheaper compared to in-the-money options and offer leveraged exposure to price movements in the underlying asset. They are often used in speculative strategies or as a hedge with limited upfront cost and controlled risk.
