What Does ATM Mean in Stock and Options Trading?

Options trading involves financial contracts that provide rights concerning an underlying asset. Understanding key terms such as “At The Money” (ATM) is important for anyone considering these instruments. This article explains what “At The Money” means in the context of stock options, defining its characteristics and differentiating it from other common options classifications.

Understanding Foundational Options Concepts

Options are financial contracts that derive their value from an underlying asset. These contracts provide the holder with the right, but not the obligation, to buy or sell the underlying asset at a specified price within a certain timeframe.

A core component of an option contract is the “underlying asset,” the security or instrument the option is based upon. A stock option contract represents 100 shares of the underlying stock. The “strike price” is the specific price at which the underlying asset can be bought or sold if the option is exercised.

Every option contract also has an “expiration date,” which is the final date by which the option can be exercised. After this date, the option becomes worthless if not exercised or closed out. There are two types of options: call options and put options.

A “call option” grants the buyer the right, but not the obligation, to purchase the underlying asset at the strike price on or before the expiration date. Conversely, a “put option” provides the buyer with the right, but not the obligation, to sell the underlying asset at the strike price on or before the expiration date. Buyers of calls anticipate an increase in the underlying asset’s price, while buyers of puts expect a decrease.

Defining At The Money (ATM) Options

An option is considered “At The Money” (ATM) when its strike price is approximately equal to the current market price of the underlying asset. This applies to both call and put options. For example, if a stock is trading at $50, a call option with a strike price of $50 would be considered ATM. Similarly, a put option with a $50 strike price would also be ATM if the stock trades at $50.

In practice, an exact match between the strike price and current market price is often fleeting. Therefore, an option might be referred to as ATM if its strike price is very close to the underlying asset’s current trading price. For instance, if a stock is trading at $105.08, a $105 strike option might still be viewed as ATM because of its proximity to the market price.

The state of an option being ATM is dynamic, shifting with the movement of the underlying stock’s price. A small fluctuation in the stock’s value can quickly move an ATM option to an “In The Money” (ITM) or “Out of The Money” (OTM) status. This sensitivity means that ATM options are responsive to minor price changes in the underlying asset.

The theoretical intrinsic value of an ATM option is zero, as exercising it at the current market price yields no immediate profit. Its value is derived entirely from other factors, such as the time remaining until expiration and implied volatility, which form its extrinsic value.

Distinguishing ATM from In The Money (ITM) and Out of The Money (OTM)

Understanding “At The Money” (ATM) options becomes clearer when contrasted with “In The Money” (ITM) and “Out of The Money” (OTM) options. These classifications indicate whether an option has intrinsic value.

An option is “In The Money” (ITM) when exercising it would result in an immediate theoretical profit. For a call option, ITM occurs when the underlying stock price is trading above the strike price. For example, if a stock is trading at $105, a call option with a strike price of $100 would be ITM by $5.

Conversely, for a put option, ITM occurs when the underlying stock price is trading below the strike price. If a stock is at $95, a put option with a strike price of $100 would be ITM by $5. This means the holder could sell the stock at $100, which is higher than its current market price of $95, yielding a $5 intrinsic value per share.

An option is “Out of The Money” (OTM) when it has no intrinsic value and would not result in an immediate profit if exercised. For a call option, OTM occurs when the underlying stock price is trading below the strike price. If a stock is at $95, a call option with a strike price of $100 would be OTM. Exercising this call would mean buying the stock at $100 when it could be bought for $95 in the open market, which is not advantageous.

For a put option, OTM occurs when the underlying stock price is trading above the strike price. If a stock is at $105, a put option with a strike price of $100 would be OTM. Exercising this put would mean selling the stock at $100 when it could be sold for $105 in the open market, which is not beneficial. OTM options consist entirely of extrinsic value, and they will expire worthless if they remain OTM at expiration.

In comparison, ATM options exist at the theoretical boundary between ITM and OTM. While ITM options have intrinsic value and OTM options have none, ATM options also have no intrinsic value. However, ATM options are characterized by their strike price being equal or very close to the current market price, making them highly sensitive to price movements that could shift them into either ITM or OTM status.

Key Characteristics of ATM Options

At The Money (ATM) options possess distinct characteristics that influence their behavior and value in the market. One feature is their premium composition. The premium of an ATM option is almost entirely comprised of “extrinsic value.” Unlike “In The Money” options, ATM options carry no intrinsic value, as their strike price matches the current underlying asset price. Extrinsic value accounts for factors like the time remaining until expiration and the implied volatility of the underlying asset.

Another characteristic of ATM options is their “delta.” Delta measures how much an option’s price is expected to change for every one-dollar movement in the underlying asset’s price. ATM options have a delta close to 0.50, meaning their price moves approximately 50 cents for every dollar the underlying stock moves. For put options, the delta is around -0.50, reflecting an inverse relationship. This delta value reflects the roughly equal probability of the option ending up “In The Money” or “Out of The Money.”

Time decay, represented by “theta,” is an important aspect of ATM options. Theta measures the rate at which an option’s value erodes as it approaches its expiration date. ATM options are the most susceptible to time decay compared to ITM or OTM options. This means their extrinsic value diminishes at a faster rate as expiration nears. For option buyers, a negative theta signifies a daily loss in the option’s value, while option sellers benefit from this decay.

ATM options are sensitive to small price movements in the underlying stock. A minor shift in the stock’s price can quickly transition an ATM option into an ITM or OTM state, impacting its value and potential profitability. This sensitivity stems from their position at the equilibrium point where the strike price and current market price align, making them responsive to market fluctuations.