Getting to know out-of-money (OTM) options
Option contracts that have nothing but extrinsic values are called OTM or out of money. Their delta is even lower than 0.50. But what is delta? It is a ratio that can compare the asset's price changes and its derivative-these assets are most likely securities that people can market.
An OTM option can either be a call or put. If it is a call option, its strike price should be more than the underlying asset's market price. On the other hand, OTM put options have strike prices lower than the underlying asset's market price. If you are in this article to know what OTM means, you might as well know that its opposite is called ITM or in-the-money options.
Let start from the beginning.
Let us talk about premium first. Stock options offer a buyer the right to buy or sell the underlying asset. And when we say rights, we reiterate that it is not an obligation. Also, the price and date are already agreed upon beforehand. And since we are already here, that price is what we call the "strike price" while the date is the "expiration date."
Now, let us go back to the choices. The choice to buy the underlying asset is the "call option," while the choice to sell is the "put option." Traders will most likely buy a call option if they believe that the underlying asset's price will go beyond the strike price before the expiration date. On the other hand, traders engage with put options to take advantage of a declining asset price.
We consider options are derivatives because their value depends on underlying securities. Options can either be out of money, in the money or at the money. If it is your first time encountering ATM, it refers to an option with a similar strike and underlying asset price.
Tell me more about out-of-money options.
When is an option an OTM? Know if the underlying's current price is relative to the option's strike price. Now, we hop on to call and put options. The call option is an OTM if the underlying price is less than the strike price. The put option is an OTM if the underlying price is more than the strike price. An OTM option has nothing but time value. It has no intrinsic value. But even if we say this, it does not mean that OTM options are not profitable. You can buy a far OTM, but it can slowly become an ITM. This option can have a value more than what you paid for. However, OTM options will still become worthless as they expire. Hence, they need to be sold before they expire.
Let us have a recap
OTM options have no
intrinsic value, only extrinsic value. An OTM call option's underlying price is
lower than the strike price, while an OTM put option's underlying price is more
than the strike price. Aside from being out of money, options can also be in
the money and at the money. OTMs are cheaper than ITMs and ATMs because ITMs
have intrinsic value, while ATMs are close to having intrinsic value.
