Generally, options trading represents buying and selling contracts of options on the stock exchanges. In simple terms, it’s very similar to stock trading. An option’s value which refers to the premium fluctuates based on the price of the underlying assets. The option can be In the Money(ITM), Out of the Money(OTM), or At the Money(ATM). Let’s look at the Difference Between In the Money and Out of the Money Options. Before that, it’s important to know about intrinsic value and time value. This is because without knowing it, one cannot move forward in options trading.
The Intrinsic value for the call option will be the (underlying stock’s price – its call strike price). For the put option, it is the (put strike price – the underlying stock price). Here, ATM(At the money) and OTM (Out of the money) options don’t have any Intrinsic value.
The Time value is known as the Extrinsic value. The time value decreases to zero overtime at the time of expiration of the period. This situation is nothing but Time decay. Options premium depends on the expiration time. Options that expire after a longer period of time are more expensive in comparison to those expiring in the current month.
Types of Options on the Basis of Moneyness
In the Money Options
An In-the-Money call option represents a call that strikes (exercise) price is lower in comparison to the present underlying stock price. An In-the-Money put refers to a put which strikes (exercise) price is higher compared to the present price of the underlying. If investors would exercise an ITM option by buying or selling stock to offset the exercise, they would get more cash for selling.
Out-of-the-Money Options
An Out-of-the-money call means a call in which the exercise price (strike price) is higher compared to the present price of the underlying. Thus, the entire premium of an out-of-the-money call option contains only extrinsic value. So, it is advisable not to exercise an out-of-the-money option, as an investor would generally get a better price if he trades the underlying in the stock market without using the option.
Checking the Difference Between In the Money and Out of the Money Options with Real-Life Examples
Example of In the Money Options (ITM):
- An in-the-money option is a contract that has intrinsic value due to its underlying security price being above or below the strike price.
- For example, if you bought a Nifty Call option with a strike price of 10000 and Nifty is currently trading at 10500, then your call option will be In-the-Money (ITM) by 500 points.
- This gives you the legal right to buy Nifty at 10K even though its current market prices are much higher than that. You can enjoy this gain when you exercise your ITM options or sell it off before expiry.
Example of Out of The Money Options (OTM):
- An out-of-the-money option is a contract that does not have any intrinsic value because its underlying security price lies the same as the strike price or anywhere close to it but not above/below it.
- Let’s consider the same example as mentioned earlier for reference. Suppose, you own a Put Option with a strike Price at 10100 and spot Nifty is trading around 9950 now. Here underlying security i.e., the nifty index is trading lower than Strike Price. Therefore, this puts us in OTM Position by 150 Points. Or else if Spot goes exactly the same as Strike i.e. 10100 so we again find ourselves in the OTM position (-0). So all these provides Opportunity for the seller where they won’t receive anything on exercising them or maybe OTMs hold time decay nature.
Key Difference between ITM and OTM Options
- In the Money: It has positive intrinsic value. Calls options carry low strikes while puts have high strikes.
- Out of the Money: Zero intrinsic value with high strikes in calls and low strikes input.
FAQ
It depends on several factors, such as your risk appetite, how the market is moving, and the cost of purchasing. In general, ITM (in-the-money) options have some intrinsic value at expiry and may suit those wanting a greater likelihood of a profitable outcome. On the other hand, OTM (out-of-the-money) options may be more suitable for high-risk traders who are comfortable with larger losses in exchange for potentially higher returns.
If an OTM option expires worthless then you will lose any premium paid upfront when writing/buying them. However, if they’re ITM upon expiry then profits may be made depending on whether writing or buying them. Writing brings with it additional risks than just simply buying so please invest responsibly and within your means.
An in-the-money option of Nifty refers to an option contract that has intrinsic value based upon its underlying asset(s). A large portion of this intrinsic value will depend upon where Nifty’s spot price is trading versus where you set your strike price when entering into the position. For example, if you purchase a call option with a strike price lower than Nifty’s current bargain rate – then it would be classed as having intrinsic value due to being ‘In The Money’ at the maturity date.
Conclusion
The difference between In The Money and Out of The Money Options depends on the price of the underlying asset. If the strike price of an option is below or higher than its current market value for a Call Option or Put Option respectively, then such options are in-the-money options. On the other hand, if they trade at the same monetary value as the underlying security, they are considered to be out-of-the-money. Moreover, the intrinsic value associated with these two types gives them advantages over other derivatives instruments used by investors.
