Options Explained: In the Money vs. Out of the Money Differences

Search Fintrev

Search our guides, reviews and glossary.

An option is in the money (ITM) when exercising it right now would be worth something, and out of the money (OTM) when it would not. For a call, that means ITM when the underlying price is above the strike price and OTM when it is below. For a put, the rule reverses: ITM when the underlying is below the strike, OTM when it is above. When the underlying trades at or very near the strike, the option is at the money (ATM). This relationship between strike and market price is called moneyness. It decides how much of an option’s price is intrinsic value and how much is time value.

How moneyness is determined

Call options

A call gives the buyer the right, but not the obligation, to buy the underlying at the strike price before or at expiration. That right has exercise value only if the market price is higher than the strike.

• ITM call: underlying price above the strike
• ATM call: underlying price at or near the strike
• OTM call: underlying price below the strike

Put options

A put gives the buyer the right to sell the underlying at the strike price. That is useful only when the market price is lower than the strike.

• ITM put: underlying price below the strike
• ATM put: underlying price at or near the strike
• OTM put: underlying price above the strike

One consequence: at any given price, a call and a put with the same strike are on opposite sides. If a stock trades at $50, a $45 call is ITM and a $45 put is OTM. In an option chain, ITM strikes for calls sit below the current price and ITM strikes for puts sit above it.

Intrinsic value and time value

An option’s premium has two parts:

• Intrinsic value is what the option would be worth if exercised immediately. For a call, it is underlying price minus strike. For a put, it is strike minus underlying price. If the result is negative, intrinsic value is zero, never below.
• Time value is everything else in the premium: premium minus intrinsic value. It reflects the chance that the underlying will move favorably before expiration. Buyers pay for that chance, and writers need compensation for the risk of it.

The further an option is from expiration, the more time value it generally carries, because the underlying has more time to move. As expiration approaches, time value shrinks toward zero. At expiration, an option is worth only its intrinsic value.

Example: an ITM call

As a hypothetical example, suppose a stock trades at $135 and a call has a strike of $132.50. The call is ITM by $2.50, so its intrinsic value is $2.50 per share. If the call is quoted at $5.00, the remaining $2.50 is time value. A call on the same stock with a $140 strike would be OTM. Its intrinsic value is zero, and whatever it costs is time value only. Actual premiums depend on time to expiration, volatility, interest rates and supply and demand.

Example: an ITM put

Suppose a put has a strike of $75. If the stock trades at $72, the put is ITM with $3 of intrinsic value, because it lets the holder sell at $75 something worth $72. If the stock instead trades at $80, the same put is OTM and has no intrinsic value.

Exceptions that change the answer

ITM is not the same as profitable. Take the call above: bought for $5.00 with a $132.50 strike. At expiration, the stock must be above $137.50 (strike plus premium paid, before commissions) for the trade to make money. If the stock finishes at $135, the call is still ITM and worth $2.50, but the buyer has lost $2.50 per share. For a long put, the breakeven is strike minus premium paid.

Moneyness changes constantly. It is a snapshot, not a fixed feature of the contract. A call that is OTM in the morning can be ITM by the afternoon if the underlying rallies through the strike, and it can slip back again. Only the status at expiration (or at the moment of exercise) settles what the option pays.

ATM is a zone, not an exact price. Traders usually call the strike nearest the current price “at the money,” even when it is not an exact match. ATM options carry no intrinsic value, but they typically have the most time value in the chain, because the outcome is most uncertain there.

The writer sees the mirror image. The terms always describe the option from the holder’s side. For the writer, ITM is the unfavorable state, because the holder may exercise and the writer must deliver or buy the underlying at the strike. Writers generally want the contract to stay OTM so it expires worthless and they keep the full premium. That is why a covered call seller often chooses an OTM strike, so the shares are less likely to be called away.

Choosing between ITM and OTM options

ITM options cost more because they include intrinsic value. In exchange, their price tracks the underlying more closely, and less of the premium is time value that can decay away. Traders use them for exposure that behaves more like owning or shorting the underlying, or to hedge an existing position. Because the premium is larger, their percentage moves are usually smaller than those of OTM options in the same chain.

OTM options are cheaper because they consist entirely of time value. That lower up-front cost appeals to traders with limited capital and to those expecting a large move. If a stock trades at $100, a trader who believes it can rise well beyond $102.50 might buy the $102.50 call instead of a more expensive ITM strike. The trade-off is that the underlying has to move past the strike, and also far enough to cover the premium, before expiration. If it does not, the option expires worthless and the buyer loses the full premium.

Low prices also make OTM options volatile in percentage terms. A call that moves from $0.10 to $0.15 has gained 50%, and a drop of the same size erases half its value. This leverage is why OTM options are considered the riskier purchase: the maximum loss on any long option is the premium paid, and an OTM option is more likely to lose all of it. The same holds for long puts. The OTM put costs less but is more likely to expire worthless, while part of an ITM put’s cost is intrinsic value already in place.

What ITM means in forex trading

Currency options use the same definitions, with an exchange rate in place of a share price. A EUR/USD call with a 1.1000 strike is ITM when the spot rate is above 1.1000 and OTM when it is below. A put at that strike is ITM when the rate is below 1.1000. Intrinsic value is the difference between spot and strike, multiplied by the contract’s notional amount. In spot forex, ITM has no standard meaning: a spot position is described as in profit or in loss.

FAQs

The Bottom Line

Option buyers and writers both need to read moneyness correctly, since it sets how much of a premium is intrinsic value and how much can decay away. ITM options cost more and track the underlying more closely, while cheaper OTM options need a larger move and more often expire worthless. Currency options follow the same rules, using an exchange rate instead of a share price.