Moneyness of an option
Moneyness is a strange sounding term, but it is sometimes used for describing the amount of intrinsic value an option has. All options belong to one of the three basic groups (and they can move between these groups as the market price of the underlying changes, as you will see below). The three groups are:
- In the money options
- At the money options
- Out of the money options
Shortcuts are frequently used for these terms and they are also used here on Macroption. In the money is ITM, at the money is ATM, and out of the money is OTM.
In the money options
An option is in the money if its intrinsic value is greater than zero (probably the most important sentence of this article, read it once again).
This means that if you would exercise an in the money option and immediately buy or sell the underlying stock in the stock market to offset the exercise, you would get more cash for the selling than you give away for the buying (you would be net cash positive from these transactions).
ITM call options – lower strikes
For a call option being in the money means that the market price of the underlying stock (or underlying security in general) is higher than the strike price of the call option. If you exercise the call, you would be buying the underlying stock for the strike price and then you could immediately sell the stock in the stock market for the market price, which would be higher. The difference, which is equal to the call option’s intrinsic value, would be your net cash inflow from the transaction.
ITM put options – higher strikes
For a put option things are just inverse. A put option is in the money when its strike price is higher than the current market price of its underlying security. You can buy the stock for the (lower) market price in the stock market and exercise the put option, which means selling the stock for the (higher) strike price. The amount by which the market price of the stock is lower than the option’s strike price is the put option’s intrinsic value, or as people say the value by which the option is in the money. Yes, all in the money options are not equal. Some are more ITM than some other.
How this relates to option prices
From the descriptions above it is evident that owning and ITM option is a good thing and the more in the money the option is, the higher intrinsic value it has, and the more valuable it is (other things being equal). Therefore, holding all other parameters constant, the more in the money an option is, the higher its price.
For calls, the lower the strike price, the cheaper you can buy the underlying if you exercise the call option, the more intrinsic value it has, the more ITM it is, and the more expensive the option itself is.
For puts, the higher the strike price, the higher you can sell the underlying if you exercise the put option, the more intrinsic value it has, the more ITM it is, and the more expensive the option itself is.
Out of the money options
Out of the money options are, as the name suggests, the opposite of in the money options. They are options whose intrinsic value is zero (it can’t be negative). OTM call options have a strike price higher than the current market price of the underlying. OTM put options have a strike price lower than the current market price of the underlying. It is not a good idea to exercise an out of the money option, as you would simply get a better price if you trade the underlying in the stock market without using the option.
At the money options
At the money options are somewhere in between ITM and OTM options. They are the options whose strike price is roughly equal to the current market price of the underlying. They are exactly on the edge. At the money options are usually among the most traded (most liquid) options, as they are the most “exciting” – in a short moment they can get in the money or out of the money as the market price of the underlying fluctuates.
Summary – to keep it simple and short
In the money (ITM): positive intrinsic value, generally calls with low strikes and puts with high strikes.
At the money (ATM): zero intrinsic value, strike price equal to market price of the underlying.
Out of the money (OTM): zero intrinsic value (because intrinsic value can’t be negative), generally calls with high strikes and puts with low strikes.