What is an out of money option?
Out-of-the-money call options
A call option is considered out-of-the-money (OTM) when the underlying asset's current market price is lower than the option's strike price. Exercising the option in this situation wouldn't be profitable because you'd be buying the asset for more than its current market value.
“Out-of-the-money” refers to the term one may use in options trading. It can be narrated as an option contract that does not have an intrinsic value if practiced today. In other words, such options trade below the underlying asset value. Hence, it only has a time value.
An option that's in the money is an option that presents a profit opportunity due to the relationship between the strike price and the prevailing market price of the underlying asset. An in-the-money call option means the option holder can buy the security below its current market price.
ITM options have intrinsic value and are priced higher than OTM options in the same chain, and they can be immediately exercised. OTM are almost always less costly, making them more desirable to traders with smaller amounts of capital.
Example 2: Put Option
In another scenario, if a stock is trading at Rs. 70, and an investor has a put option with a strike price of Rs. 60. Here, the market price being higher than the strike price renders this put option OTM.
Limited risk: Because the strike price of OTM options is higher than the current market price of the underlying asset, the potential loss is limited to the premium paid for the option. This can be an attractive option for traders who are risk-averse or who want to limit their potential losses.
Out-of-the-money options may seem attractive since they are less expensive. However, remember that there is a reason for this: chances of profit at expiration are slimmer than for at-the-money or in-the-money options. There is no best choice. The choice of a strike price mainly depends on the target price.
Because OTM options have such low premiums they can also provide the trader with a significant amount of leverage because you can control large positions for a small premium. However, it is also true that an OTM option is less sensitive to price moves than the ITM or ATM option.
Out-of-the-money (OTM) options are cheaper than other options since they need the stock to move significantly to become profitable. The further out of the money an option is, the cheaper it is because it becomes less likely that underlying will reach the distant strike price.
What is the meaning of out of money?
Out of the money (OTM) refers to options that do not have any intrinsic value; they only have extrinsic, or time value. For a call option to by OTM, it will have a strike price that is above the current market level. An OTM put with have a strike price that is below the current market price.
When options expire, in-the-money options are typically exercised automatically, leading to the purchase or sale of the underlying asset at the strike price. Meanwhile, out-of-the-money options expire worthless, resulting in the loss of the premium paid by the holder.
An At-the-money call option is described as a call option whose strike price is approximately equal to spot price of the underlying assets (i.e. Strike price=Spot price). Hence, NIFTY FEB 8300 CALL would be an example of At-the-money call option, where the spot price is Rs 8300.
Out-of-the-money options occur when the current market price of the underlying asset is unfavorable for the option holder's profit. A call option is OTM if the asset's market price is below the option's strike price, while a put option is OTM when the asset's market value exceeds the put option's strike price.
Investors can realise a profit through the put OTM option by selling the asset when its value experiences a significant increase before the contract's expiration date. Otherwise, no profit can be made, as trading the stock at the market value would offer a superior return compared to the strike price.
They are called “in the money” because the strike price is favourable compared to the current market price of the underlying asset. This means that if exercised, the option immediately results in a profit. Profit Potential: ITM call options offer an opportunity for substantial profits.
Out-Of-The-Money (OTM)
If this happens, the trader would lose all value paid for the option up front and realize max loss. Prior to expiration, the trader can exit the position by selling it for the market value.
Out-of-The-Money (OTM) Call Option
For example, if the strike price is ₹12,200 and the spot price is ₹12,000 in the Nifty options, such as NIFTY MAY 12,200 CALL, it is an OTM call option. This option only has time value and no intrinsic value.
In options trading, out-of-the-money (OTM) options tend to be more volatile but can also be more profitable if the market moves in the direction you anticipate. However, they come with higher risk since they have a lower probability of expiring profitably.
A covered call can compensate to some degree if the stock price drops, the short call expires OTM, and the premium received from the short call offsets the long stock's loss. But if the stock drops more than the premium received from selling the call option, the covered call strategy begins to lose money.
What happens if you don't sell OTM options?
Contracts expiring OTM - OTM option contracts expire worthlessly. The entire amount paid as a premium will be lost. Brokerage will only be charged on one side, which is when the options are purchased, and not when they expire worthless on the expiry day.
The OTM eliminates the need for multiple cheques and minimises the risk of rejection due to signature mismatches. How many SIPs can be registered with one OTM? There is no limit to how many Systematic Investment Plans (SIPs) you can register under a single One Time Mandate (OTM).
In most cases, exercising an OTM option doesn't make sense. Therefore, most options that don't move into the money before expiration are allowed to expire worthless. That being said, options owners do always have the right to exercise before or upon expiration, even if their options are out of the money.
If an option expires out-of-the-money, it therefore expires worthless, and it disappears from the account. For long in-the-money options, market participants may decide (in certain cases) not to exercise a given option. In such cases, the investor/trader submits a Do Not Exercise Request (DNE Request) to their broker.
OTM options provide more upside leverage if you expect a larger move. The lower premium cost leaves more room for the Option to increase in value. But if you anticipate a smaller directional move, ITM options have a higher likelihood of earning a profit. Paying an extra premium provides more downside protection.
