Moneyness Of Options

The relationship between an option strike price to the underlying stock price is the concept of “moneyness” of options.

One of the first things to learn in option trading is the definition of in-the-money, out-of-the-money, and at-the-money.

They are often abbreviated ITM and OTM and ATM.

In short, a put option is in-the-money if the stock price is below the strike price of the option.

Otherwise, it is out-of-the-money.

A call option is ITM if the stock price is above the strike price.

Otherwise, it is OTM.

Technically speaking, ATM is if the price and the strike price happens to coincide exactly.

However, loosely speaking it is the two strike prices in the option chain that is closest to the price.

Example of In-the-Money

Suppose that SPY is trading at $347.50 on October 15, 2020.

If we have the $360 put option of SPY, that option will be ITM.

At this point, the 360 put has $12.50 per share of intrinsic value.

Intrinsic Value versus Extrinsic Value

If the 360 put is trading for a price above 12.50 then any extra vale is extrinsic value which is sometimes referred to as time value or time premium.

It does not make sense to exercise OTM options because there is no intrinsic value.

The $360 SPY put with November 20, 2020 expiration costs $16.43. Of that, $12.50 is intrinsic value. And the remaining $3.93 is extrinsic value.

Example of Out-of-the-Money

Now suppose that we have the $320 put option on SPY.

This option is out-of-the-money because it doesn’t make sense to exercise it.

We wouldn’t want to sell SPY at $320 when the current price of SPY is $347.50.

If we look at the price of this option at the Nov 20 expiration, we see that it costs $3.51.

The entire cost is time premium.

There is no intrinsic value in this option at this time.

Keep in mind that options and go in the money and out of the money from day to day and from minute to minute depending on the price movement of the stock and where that price is relative to the strike price of the option.

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Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are ...

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