What Does Out of the Money Mean? OTM Calls, Puts and Spreads

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Out of the money (OTM) describes an option that would have no value if exercised right now. A call is out of the money when the underlying price is below the strike price. A put is out of the money when the underlying price is above the strike price. An OTM option has zero intrinsic value, so its entire premium is time value: what the market pays for the chance that the price moves past the strike before expiration. The same idea applies to spreads. An out of the money put spread uses two put strikes that both sit below the current price of the underlying.

Moneyness for calls and puts

Moneyness compares the strike price with the current price of the underlying asset, which can be a stock, an index, a futures contract or a currency pair. As the basics of options explain, a call gives the right to buy at the strike and a put gives the right to sell at the strike.

The relationship is easy to reverse. A call with a strike below the stock price is in the money, because it lets you buy for less than the market. A call is OTM when its strike is above the stock price. Consider a stock trading at $100. A $120 call is OTM because nobody exercises a right to pay $120 for something worth $100. A $120 put on the same stock is ITM. A $90 put is OTM.

“Near the money” is an informal label for strikes close to the current price on either side. The term has no fixed threshold.

Intrinsic value, time value and the premium

An option’s premium has two parts:

Premium = intrinsic value + time (extrinsic) value

Intrinsic value is what exercise would capture today:

• Call intrinsic value = max(0, underlying price − strike)
• Put intrinsic value = max(0, strike − underlying price)

For an OTM option, both formulas return zero, so whatever it trades for is pure time value. At expiry, with no time left, an option still OTM is worth nothing.

Three main inputs drive how much time value an OTM option carries:

1. Time to expiration. More time gives the underlying more room to cross the strike.
2. Volatility. Higher expected volatility, measured by implied volatility, raises the odds of a large move.
3. Distance from the strike. The further OTM, the less the option is worth.

Pricing models such as the Black-Scholes model combine these inputs. Option Greeks describe how an OTM premium responds to each one. Delta is low for far OTM options. Theta measures the daily erosion of time value, and vega measures sensitivity to volatility.

Time value tends to be largest for at-the-money options, where the uncertainty about crossing the strike matters most. Much of an ITM option’s price is intrinsic value already locked in, so it usually carries less time value than an ATM option.

Worked example: an OTM call and an OTM put

These figures are hypothetical. They assume one contract covers 100 shares and ignore fees and early exercise.

OTM call. A stock trades at $120. A trader buys a call with a $150 strike expiring in five months, paying $1.00 per share. The total outlay is $100.

• Breakeven at expiration: $150 + $1.00 = $151.
• At $140 at expiration: the call expires worthless, and the loss is $100.
• At $151: intrinsic value is $1.00, and the result is breakeven.
• At $170: intrinsic value is $20, so the contract is worth $2,000, for a $1,900 gain.

The trader need not hold to expiration. If the stock climbs to $145 with a few weeks left, the call is still OTM but may trade near what was paid, because a $5 move remains possible. Selling then recovers most of the premium. Waiting risks the stock stalling while time value bleeds away.

OTM put. A stock trades at $100. A trader buys a $90 put for $1.50, or $150 per contract.

• Breakeven at expiration: $90 − $1.50 = $88.50.
• Above $90 at expiration, the put expires worthless. Between $88.50 and $90, it has some value but still loses money.

So an option can be in the money and still show a loss. Moneyness measures the strike against the price. Profit measures the option’s value against what you paid. An option slightly ITM at expiration loses money if its intrinsic value is less than the premium.

Out of the money spreads

A vertical spread combines a long and a short option of the same type and expiration at different strikes. When both strikes are OTM, the spread is called an OTM spread.

Long OTM put spread (bear put debit spread)

Hypothetical setup: the stock is at $100. The trader buys the $95 put for $2.00 and sells the $90 put for $0.80. The net debit is $1.20, or $120 per spread. Values are at expiration, ignoring fees.

• Maximum loss: $120, if the stock is at or above $95.
• Maximum profit: ($95 − $90 − $1.20) × 100 = $380, if the stock is at or below $90.
• Breakeven: $95 − $1.20 = $93.80.

The short $90 put lowers the cost compared with buying the $95 put alone. In exchange, it gives up any gain below $90.

Short OTM put spread (bull put credit spread)

This is the reverse trade. The trader sells the $95 put for $2.00 and buys the $90 put for $0.80, collecting a $1.20 credit, or $120.

• Maximum profit: $120, if the stock stays at or above $95 and both puts expire worthless.
• Maximum loss: $380, if the stock finishes at or below $90.
• Breakeven: $93.80.

A short OTM call spread works the same way above the market. You sell a call with a strike above the price and buy a higher-strike call. You keep the credit if the stock stays below the lower strike.

Selling OTM options without a spread

A trader who sells one OTM call and one OTM put with no protection holds a short strangle. That position has no cap on loss if the price rises sharply, and a large loss if the price collapses. Buying further-OTM options on each side turns it into an iron condor with defined risk. Whether further hedging is needed depends on the trader’s risk limits and the broker’s margin rules, not on the options being OTM.

How traders use OTM options

• Low-cost directional bets. An OTM call or put costs less than an ITM option on the same expiration. A given move therefore produces a larger percentage return, and the dollar risk is limited to the premium.
• Hedging. A portfolio holder can buy OTM puts as protection against a large decline. The holder absorbs the first part of any drop in exchange for a lower cost.
• Income. Writers of covered calls often choose OTM strikes. The stock can rise up to the strike before the shares are called away, and the writer keeps the premium.

OTM options exist on currencies too. A forex trader might buy an OTM put on a currency pair to hedge against a sharp drop in the base currency.

Limitations and risks

• Lower probability of payoff. A cheaper premium reflects lower odds of finishing ITM. The low price is not a discount.
• Time decay. All of an OTM option’s value is time value, and that value shrinks as expiration approaches. The underlying can move the right way and the option can still lose value if the move is too small or too slow.
• Volatility drops. If implied volatility falls, for example after an earnings release, an OTM premium can shrink even when the price barely changes.
• Short-side assignment. American-style options can be exercised any time up to expiration, so a seller can be assigned early if the option moves ITM.
• Liquidity. Trading activity varies by strike. Check the bid-ask spread and open interest on a specific contract before relying on getting a fair fill.

FAQs

The Bottom Line

Options buyers, hedgers and covered call writers all deal with OTM strikes, which cost less because the odds of finishing in the money are lower. Time decay and falling implied volatility can erode an OTM premium even when the price moves the right way. Sellers should define risk with spreads, and traders should check the bid-ask spread and open interest before entering a position.