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ATM, ITM, and OTM Options - Options Pricing - Options Mechanics - YouTube
Channel: Option Alpha
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Hey everyone.
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This is Kirk, here again at Option Alpha and
this is the video tutorial for one of the
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bigger topics when it comes to options trading
basics and that’s option moneyness.
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We’re going to get right into it here.
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And options are generally classified by traders
into three distinct categories.
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We usually have them by their little acronyms
and that’s ITM which is in the money options,
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ATM which are at the money options and OTM
which are out of the money options.
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Again, these are used to quickly reference
different options when building complex strategies.
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For example, if I was to email one of my members
trying to help them out with a trade, I could
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email them and say, “John Smith, buy one
at the money call and sell one in the money
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put,” whatever the case is.
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It just helps us quickly reference where options
are located on a pricing table.
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Let’s actually look at a call option as
our base example here and then we’re going
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to look at a put option right after this.
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If you look at this call option here, you
can see that we have a strike price of $40
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and that’s where the option pivots.
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When we look at our moneyness, you can see
that in the money options are going to have
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a stock price that is less than the strike
price.
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If the strike price is $40 and the stock price
is $50, then that is going to be considered
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an in the money call.
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An at the money call, the stock price is going
to be equal to the strike price.
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If we have a strike price of $40 and the stock
is also trading at $40, that means that our
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option is right at the money.
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It’s not in the money.
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It’s not out of the money.
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It’s right at the market.
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It’s right on that edge of being on either
the other categories.
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And then finally, we have an out of the money
option and in this case, the stock price is
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going to be lower than the strike price.
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If we have a stock price of $30 and our strike
price is $40, then that is clearly going to
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be very, very much out of the money call.
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The call hasn't even been close to the market
price.
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The market has to rally considerably for that
option to make money.
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Flipping it around here, we’re going to
look at a put option.
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Again, most of the things are similar, it’s
just kind of flipped around, so it’ll take
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you a little bit to understand it, but if
you have an in the money put, you’re going
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to have a stock price which is less than the
strike price.
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Our 40 strike put here just flipped around
and the stock price is $30, that means that
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we’re going to be in the money about $10
because we can sell the stock at $40 and buy
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it back at $30.
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An at the money option is going to be just
the same for a put and a call.
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It’s going to be an option that is right
at the money with the strike price and stock
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price being roughly equal, so right around
$40.
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And then an out of the money put is going
to be a put where the stock price is higher
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than the strike.
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Again, remember we're dealing in puts here,
so if the stock price is $50 up here and the
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strike price is $40, then we are out of the
money by about $10 before we ever make any
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money at expiration.
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Let’s use this visual example here really
quickly just to see where at the money, in
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the money, etcetera are.
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If we have a strike price of $40 for example
on this option, let’s say we have a call
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option with a strike price of $40 and the
market is trading at $45, then our strike
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price is considered in the money.
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It’s less than the market price for a call
option.
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If we have a call option with a strike price
at $45 and the stock is trading right at $45,
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then our strike price is at the money.
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It’s right at the market price.
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And again, if we have a strike price of $50
and the stock is trading at $45, then our
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strike price is considered out of the money.
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It’s not making any money if we were to
go to expiration right today.
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Let's throw a little curve ball here.
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This is actually a spread.
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It’s a combination of two different option
contracts that create this different diagram
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that we talked about.
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In this particular example, what you really
want to focus on here is just where the strategy
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makes money (here’s the zero profit loss
line) at expiration.
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That's really where you want to focus.
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Really, anything around $37 or so would be
considered at the money for this particular
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contract, anything inside or below $37 would
be in the money and then anything above $37
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would be out of the money because we lose
money at expiration if it’s anywhere above
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$37.
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That's really the difference.
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When you're combining options, just make sure
you take time and look at these profit loss
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diagrams.
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Remember that option moneyness and option
premiums are determined by two major components.
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We have intrinsic value or the value right
now and then we have extrinsic value or time
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value of the option.
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Those two things come together and that creates
the option premium or the total price.
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Just remember that an option with intrinsic
value is in the money and does have value
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at expiration, has value right now if it were
to expire, if it were to go to expiration
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today.
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And that's really one of the ways that you
can determine if an option is in the money,
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out of the money or at the money.
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As always, I hope you guys really enjoyed
this video and learned a lot about option
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moneyness.
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If you want to share this video with any of
your friends, colleagues or co-workers, just
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use the social media links right below this
video and share it on your favorite social
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