What Is an Out of the Money (OTM) Option?

Options are financial contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a preset price within a specific timeframe. These contracts derive their value from an underlying asset. Understanding an option’s “moneyness” is important for participants in the options market. “Out of the Money” (OTM) describes a relationship between an option’s strike price and the underlying asset’s market price.

Understanding Out of the Money (OTM)

An Out of the Money (OTM) option has no intrinsic value. If exercised immediately, it would not be profitable. The OTM status is determined by comparing its predetermined strike price to the underlying asset’s current market price.

Because OTM options lack intrinsic value, their premium is composed entirely of time value. Time value represents the possibility the option could become profitable before its expiration date. As the option approaches expiration, this time value erodes, a phenomenon called time decay. An OTM option relies solely on a favorable movement in the underlying asset’s price before expiration to gain value.

OTM Status for Call Options

A call option grants its holder the right to purchase an underlying asset at a specified strike price. A call option is Out of the Money (OTM) when the underlying asset’s current market price is below the option’s strike price. Exercising the option would not be financially advantageous, as the buyer would pay more than its current market value.

For example, if an investor holds a call option for a stock with a strike price of $50, and the stock is currently trading at $45 per share, the call option is OTM. Buying the stock at $50 would be more expensive than purchasing it on the open market at $45. For the option to become profitable, the underlying stock’s price would need to rise above the $50 strike price before expiration.

OTM Status for Put Options

A put option provides its holder the right to sell an underlying asset at a specified strike price. A put option is Out of the Money (OTM) when the underlying asset’s current market price is above the option’s strike price. Exercising an OTM put option would not be profitable, as the holder would sell the asset for less than its prevailing market value.

For instance, if an investor has a put option for a stock with a strike price of $150, and the stock is trading at $155 per share, the put option is OTM. Selling the stock at $150 would yield less than selling it on the open market at $155. For this put option to gain intrinsic value, the underlying stock’s price would need to fall below the $150 strike price before the option expires.

Comparing OTM, ITM, and ATM Options

The “moneyness” of an option describes the relationship between its strike price and the underlying asset’s current market price, categorizing options into three states: Out of the Money (OTM), In the Money (ITM), and At the Money (ATM). OTM options possess no intrinsic value and rely solely on time value for their price. They are typically less costly to acquire due to their lack of immediate profitability.

In contrast, an In the Money (ITM) option has intrinsic value, meaning it would be profitable to exercise immediately. For a call option, it is ITM when the underlying asset’s price is above the strike price. For a put option, it is ITM when the underlying asset’s price is below the strike price. ITM options generally have higher premiums compared to OTM options because of this inherent value.

At the Money (ATM) options occur when the underlying asset’s current market price is approximately equal to the option’s strike price. ATM options have very little intrinsic value but contain a significant amount of time value. While OTM options require a favorable price movement to become profitable, ITM options offer immediate profit potential, and ATM options are on the cusp of developing intrinsic value.