The terms ATM, OTM, and ITM are fundamental concepts in options trading. Understanding these classifications can enhance your trading strategy and decision-making. This guide explains their meanings, differences, and practical implications.
Core Options Terminology
Before diving into ATM/OTM/ITM, familiarize yourself with these key terms:
- Strike Price: The predetermined price at which an option can be exercised.
- Spot Price: The current market price of the underlying asset.
Intrinsic Value: The inherent value of an option if exercised immediately.
- Call Option: Spot Price − Strike Price
- Put Option: Strike Price − Spot Price
(Intrinsic value is never negative.)
Understanding Moneyness: ATM, OTM, ITM
"Moneyness" describes the relationship between an option's strike price and the spot price. It categorizes options into three types:
1. At The Money (ATM)
- Definition: Strike price ≈ Spot price.
- Example: Spot price = ₹8,200; Strike price = ₹8,150 (intrinsic value = ₹50).
Characteristics:
- Moderate premium cost.
- Contains only time value (no intrinsic value).
- Balanced risk-reward ratio.
2. Out of The Money (OTM)
Definition: Zero intrinsic value.
- Call Option: Strike Price > Spot Price.
- Put Option: Strike Price < Spot Price.
- Example: Spot price = ₹8,200; Strike price = ₹8,300 (intrinsic value = -₹100 → treated as zero).
Characteristics:
- Lower premium (only time value).
- Higher potential returns but lower probability of profitability.
3. In The Money (ITM)
Definition: Positive intrinsic value.
- Call Option: Strike Price < Spot Price.
- Put Option: Strike Price > Spot Price.
- Example: Spot price = ₹8,200; Strike price = ₹7,900 (intrinsic value = ₹300).
Characteristics:
- Higher premium (intrinsic + time value).
- Higher probability of profitability.
Time Value and Its Role
Time Value: Extra premium reflecting the potential for future price movement.
- Decays as expiration approaches.
- Longer-dated options have higher time value.
Impact on ATM/OTM/ITM:
- ATM options are purely time-value-driven.
- OTM/ITM premiums adjust based on intrinsic value and remaining time.
Options Greeks and Moneyness
Understanding Greeks helps assess risk and pricing dynamics:
| Greek | ATM | ITM | OTM |
|---|---|---|---|
| Delta | ~0.5 | >0.5 | <0.5 |
| Gamma | Highest | Medium | Low |
| Theta | Fast decay | Slow decay | Slow decay |
| Vega | High | Medium | Low |
👉 Mastering Options Greeks can refine your trading strategy.
FAQs
Q: Which option type is cheapest?
A: OTM options have the lowest premium due to zero intrinsic value.
Q: When should I trade ITM options?
A: When you seek higher probability trades and are willing to pay a higher premium.
Q: How does time decay affect ATM options?
A: ATM options suffer rapid time value loss as expiration nears.
Q: Can an OTM option become ITM?
A: Yes, if the spot price moves favorably before expiry.
Q: Why is Gamma highest for ATM options?
A: Because Delta is most sensitive to price changes near the strike price.
Key Takeaways
- ATM: Balanced, moderate cost.
- OTM: High-risk, high-reward.
- ITM: Lower risk, higher cost.
- Greeks guide strategy adjustments.
👉 Explore advanced options strategies to leverage moneyness effectively.