At the money (ATM) is a situation wherein if the option holder exercises the option, it will result in neither loss nor gain because the exercise price or strike price is equal to the current spot price of the underlying security.
the call option buyer and the put option buyer will get the same result in “at the money.” In an ATM, the situation is rare in the money market, but when it prevails, it can benefit both the buyer and sellers. Investors should carefully analyze the price which the exchange offers. Beginner investors should take extra caution while exercising this option price since it may contain a higher cost. These options are much better for very aggressive investors because they can provide a wide range of stock movements very often.
"At the money" (ATM) refers to an option where the exercise price aligns with the current spot price of the underlying security. This scenario results in no profit or loss for the investor.
To determine if an option is "in the money," the exercise price is compared to the market price. If the exercise price is lower or higher, the put or call buyer is "in the money." When they match, it's categorized as "ATM."
Before investing, carefully evaluate the cost of "at-the-money" options. It's essential to note that dealing with both put and call options in the "ATM" scenario can carry a degree of risk for beginners.
At The Money Explained
At the money option is a situation in which the exercise price for both the call buyer and the put buyer of the option is equal to the market price. When the option's exercise price is less than the market price, the situation is called as in the money for the call buyer and out of money for the put buyer of the option.
When an option is purchased, the buyer gets three situations, i.e., In the money, At the money, and the Out of the money. These three situations vary from the point of view of the buyers as well as sellers of the option. Whenever an option is purchased at that time, there are two parties: the buyer of the option and the seller of the option.
Also, there are two types of buyers: Call buyers and Put buyers. When the option's exercise price is greater than the market price, the situation is out of money for the call buyers, and the situation is in the money for the put buyers.
After exercising the option, the result is gain, and then it is said that the option is in the money, and when an option is said to be out of money at that time, the result is a loss. It is very important to relate to these three situations simultaneously. In a given situation, whenever the exercise price and the market price are the same at that time, it is always the situation of an ATM, and it is for both buyers as well as the seller.
At The Money & Other Moneyness
Besides at the money, there are a couple of other concepts associated with moneyness — out of the money or OTM and in the money or ITM. If options are ITM, they possess both time and intrinsic value. On the other hand, when options are OTM, they do not carry any intrinsic value. This means that an investor is not able to generate any profit if they exercise the option.
In the case of call options, investors take advantage by exercising at the time when the price of the underlying asset is more when compared to the strike price. Note that they do not exercise in case the spot price is less when compared to the strike price. Thus, a call option is ITM if the spot price is more than the strike price, while it is OTM if the strike price is more than the spot price.
In the case of put options, an investor exercises all put options at a price that is below the strike price for making gains. At this point, these options are ITM. If the spot price is higher in comparison to the strike price, an investor does not exercise. Hence, in this case, there isn’t any intrinsic value, and at this point, the options are OTM.
It is possible for put and call options having the exact underlying asset as well as strike price to be ATM at the same time. However, it is not possible to be OTM and ITM simultaneously.
Let us look at the following graph to understand the concept better.
For instance, suppose a put and call of ABC stock have the same $100 strike price when traded at a current price of $100. In this case, both the put and the call are ATM. When the price of the stock increases the call option is ITM and has an intrinsic value equivalent to the difference between the spot and strike prices. Simultaneously, the put option is OTM. In case the price drops, the call option is OTM, while the put option is ITM having n intrinsic value that is the same as the difference between the strike and spot prices.
Volatility SMile & At The Money
The implied volatility has a tendency to remain the lowest if an option is near or at the money. Moreover, it increases if the option makes a movement further ITM or OTM. One can plot the relationship between implied volatility and moneyness in the volatility smile.
The above u-shaped curve is not applicable to every option. The currency and equity options having short terms concerning expiration have more chances of taking on such a curve. Note that cases of volatility smirk or skew also exist, showing higher volatility if any option goes further ITM or OTM.
Implied volatility refers to a factor driving option pricing. Simply put, the more the implied volatility, the greater the price of the option. Drawing comparison with various strike prices yet identical characteristics, the curve suggests that the options prices with regard to OTM and ITM are usually higher when compared to ATM options.
Example
Let us try to understand the concept of at the money call option and put option with the help of a suitable example.
Suppose a person has bought a one month call option at a premium of $6 with an exercise price of $40. What will be the status of the current market price be $45, $40, $35?
Firstly, the option premium is irrelevant here since it is considered a sunk cost.
Now, when the market price is $45, which is more than the exercise price, the status will be in the money for the call buyers and out of money for the put buyer.
When the market price is $40, equal to the exercise price, the status will be at the money option for the call buyers which is also at the money call option, and similar for the put buyer.
When the market price is $35, which is less than the exercise price, the status will be out of the money for the call buyers and in the money for the Put Buyer.
Thus, the at the money option example explained above gives us a clear idea of the same.
Advantages
Every financial concept has its advantages and disadvantages. The benefits of the idea are elaborated below as follows:
In case of the ATM, the option has a high chance of profit-making after the expiration of the option term in comparison to the other two situations in the options pricing.
In case of at the money options strategy the option prices have parity with the market price of the option. This makes the investor's decision quite simple.
In this pricing mechanism, the option is at low risk, and the risk-avoider investors are free to invest in the money market.
Disadvantages
Along with the advantages, it is also necessary to understand the disadvantages, as given below:
This situation is more costly compared to the exchange's other two pricing.
At this price, the buyer and the seller are both required to pay a higher commission to enjoy the same benefit.
Sometimes it becomes difficult for the investors to decide regarding the investment because they cannot identify whether the option will provide gain or loss.
The option prices are beneficial to the investors but also complicated. The at the money options strategy situation is also the same. They can confuse investors, especially if they are beginners.
Practically this type of situation is very rare in the money market when the exercise price and the market price are the same, and no loss or a gain situation arises. Therefore this type of option pricing is rare.
At The Money Vs In The Money
Let us look at some fundamental differences between the two financial concepts.
The buyer or seller will not gain any loss when the option is ATM. On the other hand, when the option is ITM (In the Money), the result will be gain.
In the situation of ITM (In the Money), the intrinsic value is there, but in the case of the ATM situation, there is no intrinsic value.
If at the money option example, the exercise and market prices are the same; therefore, no loss or a gain situation arises. Whereas in the other option, the exercise price is less than the market price at that time, the option is said to be ITM( In the money).
Frequently Asked Questions (FAQs)
1. What is the importance of ATM?
ATM, or Automated Teller Machine, plays a crucial role in modern banking by providing customers convenient access to various banking services outside regular banking hours. It enables cash withdrawals, fund transfers, balance inquiries, and other financial transactions, enhancing accessibility and customer convenience.
2. What is the risk of ATM call options?
ATM (At-The-Money) call options carry risks related to market fluctuations. These options have higher premiums due to their proximity to the current stock price. The option might not generate substantial profits if the stock price doesn't move significantly. Additionally, time decay can erode the option's value as expiration approaches, potentially leading to losses if the anticipated price move doesn't occur.
3. What is OTM vs ATM?
OTM (Out-of-The-Money) and ATM (At-The-Money) refer to different positions of options relative to the current market price of the underlying asset. An OTM option has a strike price that is unfavorable for immediate exercise, as it is away from the current price. In contrast, an ATM option has a strike price close to the current market price. ATM options generally have higher premiums due to their proximity to the current price, while OTM options are typically less expensive but require a larger price move to become profitable.
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This has been a guide to At The Money and its meaning. We explain it with example, differences with in the money, advantages and disadvantages. You can learn more about it from the following articles–
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