Options Moneyness

“Options trading is like a game of poker, except you’re betting on the stock market instead of a deck of cards. And instead of bluffing your opponents, you’re trying to outsmart the market.”

Option moneyness refers to the relationship between the strike price of an option and the current price of the underlying asset. 

An option can be either in-the-money, at-the-money, or out-of-the-money. In-the-money options have a strike price that is favorable compared to the current price of the underlying asset. 

Here is a breakdown of what these terms mean and how they relate to options trading in the Indian share market:

At-the-Money (ATM) options

ATM options are those where the strike price of the option is equal to the current market price of the underlying asset. In other words, the option is neither in-the-money nor out-of-the-money. As such, the premium for ATM options is usually lower than ITM or OTM options.

For example, if the current market price of a stock is ₹1000, then an ATM call option would have a strike price of ₹1000 and an ATM put option would also have a strike price of ₹1000.

In-the-Money (ITM) options

ITM options are those where the strike price of the option is below (for call options) or above (for put options) the current market price of the underlying asset. In other words, if the option were to be exercised at that moment, the trader would receive a profit. Therefore, ITM options have a higher premium than ATM or OTM options.

For example, if the current market price of a stock is ₹1000, then a call option with a strike price of ₹950 would be considered ITM. Similarly, a put option with a strike price of ₹1050 would be considered ITM.

Out-of-the-Money (OTM) options

OTM options are those where the strike price of the option is above (for call options) or below (for put options) the current market price of the underlying asset. In other words, if the option were to be exercised at that moment, the trader would not receive a profit. Therefore, OTM options have a lower premium than ATM or ITM options.

For example, if the current market price of a stock is ₹1000, then a call option with a strike price of ₹1050 would be considered OTM. Similarly, a put option with a strike price of ₹950 would be considered OTM.

It is important to note that the moneyness of an option can change as the market price of the underlying asset changes. An option that is ATM at one point in time can become ITM or OTM at a later point in time depending on the movement of the underlying asset’s price.

Notes: 

Understanding the moneyness of an option is crucial for options traders as it affects the premium paid for an option and the potential profit or loss that can be made through the options contract. 

The strike price of an option is an important factor in determining its premium. Options with strike prices that are closer to the current spot price of the underlying asset tend to have higher premiums than those with strike prices that are further away. 

This is because options with strike prices that are closer to the current spot price are more likely to end up in-the-money, which means they will have a higher chance of being exercised.