When you’re talking about moneyness in options, certain phrases capture where the strike price is in relation to the current price of the underlying asset.
Options are either in-the-money (ITM), out-of-the-money (OTM), at-the-money (ATM), or near-the-money. You can also have options that are deep-in-the-money or far-out-of-the-money.
Generally, a call option is in-the-money when the strike price is below the underlying asset price while a put is ITM when the strike price is above the underlying asset price. You flip the relationship for out-of-the-money options: an OTM call’s strike price is above the underlying stock price while an OTM put’s strike price is below the stock price.
What Is Moneyness?
The moneyness of an option describes the relationship between the strike price of an options contract and the price of the underlying shares. To explain the strike price: it refers to the price at which an investor can buy or sell a derivative contract.
Option moneyness can change depending on how the stock price moves. For example, a call option can be out-of-the-money one day, but then a share price appreciation can result in that same call turning in-the-money the next day.
Moneyness may also change on a minute-by-minute basis depending on the price fluctuations in the underlying stock.
Moneyness of options can be used to construct your options trading strategy — e.g. going long or short options, purchasing puts or calls, and executing more sophisticated options strategies.
Recommended: How to Trade Stock Options
How Does Moneyness Work?
Understanding the moneyness of an option is important for different core options trading strategies. As explained earlier, moneyness works by comparing the strike price of an option to the market price of the underlying shares.
Because options are complex, it’s also important to know options terminology.
• An in-the-money (ITM) option has intrinsic value and time value.
• An out-of-the-money (OTM) option only has time value, and thus is worthless if exercised.
• OTM options have zero intrinsic value and thus are cheaper than in-the-money options.
• At-the-money (ATM) options are rare since it might only occur for a moment when the stock price equals a specific strike price — near-the-money options are more common.
• A near-the-money option has a strike closest to the underlying share price on an options chain.
Practically speaking, if you are very bullish on a stock, you might consider purchasing out-of-the-money call options since those would appreciate the most on a percentage basis if there is a sharp share price rise. They also drop the most if the price moves against you.
If you expect just a small move on a stock, in-the-money options are probably the better play. And due to the leverage in options ITM will provide higher returns/losses than available by purchasing the underlying stock.
The deeper in-the-money an option is, the greater the sensitivity it will have to movements in the underlying shares.
Understanding Intrinsic and Time Value of Options
What’s the difference between intrinsic value and time value? It’s important to understand how these two factors play into the value of options.
The intrinsic value of an in-the money call option is simply the price of the stock less the strike price of the option. The intrinsic value of an in-the money put is the strike price of the option less the price of the stock.
The difference between the intrinsic value and the actual current price of the option is time value. Options that are in the money always have intrinsic value. Out-of-the-money options have no intrinsic value, but they might have time value.
The drivers of time value are complex and include many factors. If you’re looking for more information, you should consider learning about the option Greeks to inform your trading strategy.
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Types of Moneyness
An option can be categorized in four common ways with respect to the relationship with its strike price and underlying share price: in-the-money, out-of-the-money, at-the-money, and near-the-money. Understanding how option pricing works between in-the-money vs. out-of-the-money options is important.
In-the-money options are those that have intrinsic value. For a call option, that means the underlying stock price is above the option’s strike price. A put option is in-the-money when the stock price is below the strike price.
If a call option is in-the-money, you can exercise the option, receive shares at the strike price, then immediately sell the shares in the market. In-the-money puts allow the option holder to sell a stock at a higher price compared to the market price of the security. Long calls are usually used to place bullish bets on a stock while long puts are generally used when a trader is bearish.
In-the-money options, while having intrinsic value, also have a degree of time value. It is often advantageous for an options trader to exit the trade in the market rather than exercising immediately.
Options that can be exercised at any time before expiration are known as American Style options. Options that can only be exercised upon expiration are European Style. There are other differences between American and European options but the different exercise options are most relevant to this discussion.
An out-of-the-money call option is one in which the strike price is above the underlying stock price. The owner of a call option hopes that the share price rises prior to expiration so that the option has intrinsic value. The seller of a call option benefits when the underlying stock price remains below the exercise price so they can keep the premium they collected when they sold to open the call.
Puts are out-of-the-money when the strike price is below the market price of the underlying shares. The owner of puts is bearish on the stock, so they want the stock to fall below the strike price so that the puts become in-the-money. Put sellers, who are neutral to bullish on the stock, hope the share price stays above the exercise price.
Out-of-the-money options do not have intrinsic value. Their premium is made up of time value only. Out-of-the-money options generally have lower premiums than in-the-money and at-the-money options since they are more likely to expire worthless.
At-the-money puts and calls have strike prices that are the same as the market price of the underlying stock. These options, like out-of-the-money options, have no intrinsic value. At-the-money options are usually more expensive than out-of-the-money options, but less expensive than in-the-money options.
This type of option moneyness means that calls and puts are heavily influenced by volatility and time decay.
Near-the-money options have strike prices that are very close to the market price of the underlying stock, so they are just slightly in-the-money or out-of-the-money.
Near-the-money options are much more common than at-the-money options since the stock price is rarely precisely at a specific strike price. Near-the-money strikes are used when a trader wants exposure to an at-the-money option that is not available in the market.
Other Moneyness Terms
Other terms for moneyness include deep-in-the-money and far-out-of-the-money. These terms have no real qualitative difference between in-the-money and out-of-the-money, but are simply intensifiers. They are, however, in fairly common usage.
What Moneyness Means to Investors
Option moneyness tells a trader important information. The trader can use the moneyness of an option to help construct a trading thesis. For example, if you believe a stock price will drop substantially over a short time frame, you might consider purchasing an out-of-the-money put option since that option type and moneyness will appreciate greatly when the stock price drops in a big way.
Moneyness of options grows more crucial when you embark on more complex options strategies since multiple option legs have different moneyness — knowing the moneyness of the options strategy is critical to understanding your exposure.
Still, an option holder might exit an option by selling or covering in the market rather than exercising early so that they can capture the time value of an option in addition to any intrinsic value.
Moneyness is used to describe where an option’s strike price is relative to the price of the underlying stock. It can help options traders gauge the amount of intrinsic value an option has and inform simple and complex options strategies.
A great way to get started is with SoFi’s options trading platform. The platform’s intuitive design makes it easy to use, whether you’d prefer to trade on the mobile app or through the web platform. You’ll also have access to educational resources to continue to help guiding you along the way.
How is moneyness calculated?
For a call option, moneyness is calculated by taking the underlying asset’s price and subtracting the option’s strike price. If that is a positive value, the call option is in-the-money. If it is a negative value, the call is out-of-the-money. The moneyness definition describes an option’s strike price relative to its underlying stock’s market price. The underlying asset price has to be above the strike price for a call to be in-the-money.
For a put option, the opposite is true: Moneyness is calculated by taking the underlying asset’s price and subtracting the option’s strike price. If that is a positive value, the put option is out-of-the-money. If it is a negative value, the put is in-the-money. The underlying asset price has to be below the strike price for a put to be in-the-money.
An at-the-money option is simple when the stock price and strike price are the same. Near-the-money options have strikes very close to the share price.
How are moneyness and delta different?
Option moneyness simply describes the price difference between a strike price and the price of the underlying asset. Delta, on the other hand, tells a trader how sensitive an option is to changes in the underlying stock.
How are moneyness and implied volatility related?
Implied volatility tends to be lowest with at-the-money options. It increases when the option moves further out-of-the-money or further in-the-money. The “volatility smile” describes the relationship between the moneyness of an option and the implied volatility.
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