Out Of The Money

Publication Date :

16 Mar, 2023

Blog Author :

Edited by :

Reviewed by :

Table Of Contents

Out Of The Money Meaning

Out of the money is the term used in options trading & can be described as an option contract that has no intrinsic value if exercised today. In simple terms, such options trade below or above the value of an underlying asset and, therefore, only have time value.

In this case, if the contact is a call option, the underlying price will be less, and for a put option, the underlying price will be more. Since there is no intrinsic value, it is less expensive. Thus, it is possible to easily identify it by comparing the underlying asset’s current price with the strike price of the option.

"Out-of-the-money" refers to the term one may use in options trading.
It can be narrated as an option contract that does not have an intrinsic value if practiced today. In other words, such options trade below the underlying asset value. Hence, it only has a time value.
It has two options: call option and put option. It is only appropriate only for experienced traders.
It also possesses calculative risk as compared to other options.

Out Of The Money Explained

Out of the money option is used in the options market under this option underlying asset has no intrinsic value. At the end of the options expiration investor has the option to whether exercise the option or lapse the option by calculating the risk and benefit from exercising or lapsing.

Out the money option is usually low in the cost than an in-the-money option. In, in-the-money option, there is an intrinsic value of an underlying asset. It is based on market predictions hence suitable only for experienced traders.

Example

Stock trades at $ 50 and investor has the option to call (to purchase) option at $ 52 strike price. If the market value of stock closes below $ 52 and the option expires "out of money,". The option is worthless since the buyer is buyer is buying out of the money calls and will lose money by exercising the option.

Similarly for put (Sale) option if the stock traded at $ 100 and the investor purchases a put option for $ 97 strike price (Contract Price) and if the market value of stock in the open market closes above $97 on the contract expiration date and the option expires then also an option is worthless as the option buyer would lose money by exercising the option.

OTM Options

There are two out of the money option call and put options.

#1 - Call Option

A call option is referred to as a purchase option. When the price in an open market is lower than the strike price, i.e., contract price, than investors should buy the option so as to make the transaction favorable. And if at the date of the end of the contract period, the investor to check whether exercising an option is beneficial or not by comparing the price with the market price.

Let us better understand the concept with the help of the following graph:

Suppose Jack, an options trader, owns a 145 Apple call Nov 20 call option, enabling them to purchase Apple stock at a price of $145 per share anytime until Nov 20, 2024. The call will be out of the money or OTM in case the asset price drops below $145, to $139, for example.

It would not make sense for Jack to exercise the option and purchase the asset at $140, because one can purchase it in the market for $139.

#2 - Put Option

A put option is referred to as a sale option. When the price in the open market is higher than the strike price, i.e., contract price than investors shouldn't exercise the option as it will be worthless to exercise the option and not a favorable transaction for an investor.

Individuals can improve their understanding of OTM put option with the help of this graph:

Let us continue with the above example of Apple stock. Sam who owns $135 Apple Put Nov 20 could offload the stock anytime they want for $135 until Nov 20 2024. That said, he would not exercise the option because a better price ($139) is available in the market.

When Call Option Expires Out Of The Money?

The call option expires out of the money when the contract or the period for which a buyer has entered into the option agreement expires. When the call option expires in out of money, the buyer no longer is able to purchase at the strike price, i.e., contract price. It has to purchase from the open market when the call option expires in out the money, and the buyer loses his right to purchase at a pre-determined price. Because of this, the buyer may lose the benefit and premium which the buyer paid.

When Put Option Expires Out Of The Money?

Similarly, the put option expires when the period of the contract expires. When the option expires out of the money, the seller can no longer sell at the strike price. Instead, it has to sell at market price, so there are chances that the market price is lower than the strike price, so the seller will lose the benefit and the premium, which is paid when buying the option.

Advantages

Some of the advantages are provided and discussed as follows-

In out of the money option selling stock has no intrinsic value
OTM option gives importance to the time value of money.
The cost of buying out of the money calls is lower than in the money option.
It involves calculative risk as compared to other options.

Disadvantages

Some of the disadvantages are provided and discussed as follows-

It depends upon market predictions; hence chances of loss are more if prediction goes wrong.
The risk from investor's points of view as chances of losing.
Out of the money option selling is suitable only for experienced options traders.

Out Of The Money Vs In The Money

An option can be in the money option, out the money option, or at the money option. Each one affects the intrinsic value of the option.

In the case of the money option, the stock has some intrinsic value, whereas in the case of out the money option, the stock doesn't have intrinsic value, and it has only time value.
In case of the in the money, a call option gives the option buyer the right to exercise shares at the strike price (contact price) if it is beneficial to do so, whereas in out the money call option gives the option whether to exercise the transaction or not to exercise the option.
Out the money options will give the larger gains/ losses as compared to in the money option.
In case of the in the money option, option gives the buyer the right to purchase the asset at the strike price, i.e., contract price on or before a particular day, whereas in out the money option buyer has the option to exercise the option before the expiry of the contract date.

Frequently Asked Questions (FAQs)

What does out-of-the-money mean in options?

One may also call the Out of the Money as OTM. It refers to an option that has only extrinsic value. For example, a call option is OTM when the underlying price trades below the call's strike price.

What is an out-of-the-money put?

The "out-of-the-money" (OTM) put is when the underlying asset's current price market is below the strike price for a call option or above the strike price for a set option.

Can out-of-the-money options be exercised?

According to the option owner, an out-of-the-money option may be exercised. Owners typically let them expire worthless. It is only occasionally the case, though, as post-market underlying moves may favor the exercise of out-of-the-money options at the expense of in-the-money options.

Are out-of-the-money options more profitable?

Out-of-the-money options execute better with a substantial rise in the underlying stock price. Thus, if one wants a minor increase, at-the-money or in-the-money options are the best alternatives.