ATM, ITM, and OTM in Options Trading: Key Terms and Concepts

Options trading is a versatile part of financial markets, offering investors various strategies for potential gains or risk management. Understanding terms like ATM, ITM, and OTM, as well as the differences between calls and puts, is essential for navigating the options market effectively. The following article explores these important terms and their roles in options trading.

What are Options?

Options are contracts granting the buyer the right—but not the obligation—to buy or sell an underlying asset at a specified price before a specific date. Unlike stocks representing ownership, options are derivative instruments that derive value from the underlying asset’s price. There are two main types of options:

• Call Options: Provide the right to buy the asset at a specific price.
• Put Options: Provide the right to sell the asset at a particular price.

The difference between call and put options lies in the direction of the trade. In the money call option can profit when the asset’s price rises, whereas a put option gains value when the asset’s price falls.

ITM, ATM, and OTM: Key Terms in Options

Three terms frequently used in options trading are ITM (in the money option), ATM (at the money), and OTM (out of the money option). The terms at the money option, in the money and out of the money option reflect the relationship between the option’s strike price and the underlying asset’s spot price (current market price).

1. ITM (In the Money call Option) – Full Form and Meaning

The ITM full form in trading is In the Money call option. This means the option has intrinsic value because the strike price is favourable to the current market price.

For Call Options, a call option is “in the money” if the strike price is below the spot price. This allows the option holder to buy the asset at a lower cost than the market, which could be profitable.

For Put Options, “in the money” option is used when the strike price is higher than the spot price, allowing the option holder to sell at a price above the market level.

2. ATM (At the Money Option) – Meaning in Options Trading

An At the Money (ATM) option has a strike price nearly equal to the spot price. This means the option’s strike price and the asset’s market price are very close, making the position neutral in value.

For Both Call and Put Options, both options are considered “at the money option” if the strike price is equal to or close to the spot price.

3. OTM (Out of the Money Option) – Full Form and Meaning

The OTM full form is Out of the Money. This refers to an option with no intrinsic value, as the strike price is unfavourable relative to the spot price.

For Call Options, a call option is OTM if the strike price is above the spot price. In this case, buying the asset through the option would be costlier than buying directly from the market.

For Put Options, an out-of-the-money option is when the strike price is below the spot price, making it cheaper to sell the asset on the market.

Key Concepts in Options Pricing: Strike Price vs Spot Price

Knowing the difference between strike and spot prices is crucial to understanding options.

• Strike Price: The price at which the option holder can buy (call option) or sell (put option) the asset.
• Spot Price: The current market price of the asset.

An option’s value and classification as ITM, ATM, or OTM largely depend on the relationship between these prices. In-the-money and out-of-the-fund options have different values based on how advantageous the strike price is relative to the spot price.

Factors Influencing Options Pricing

Options pricing is influenced by several factors beyond simply the in-the-money or out-of-the-money option status. These factors include:

1. Time to Expiration: Options lose value as they near expiration, especially if they’re ATM or OTM. This effect, known as time decay, affects ATM options more than ITM.
2. Volatility: Market volatility impacts the option’s premium. High volatility means a higher premium due to the increased chance of the option moving ITM.
3. Interest Rates: Higher interest rates may increase the cost of holding an option, slightly affecting premiums, especially for longer-term options.

How Traders Use ITM, ATM, and OTM Options

Each type of option serves different trading purposes:

• ITM Options: Because of their intrinsic value, ITM options are often used in conservative strategies. They are less risky and offer value directly from the price difference.
• ATM Options are commonly used in balanced strategies that benefit from small price moves. They are often central to methods that rely on price swings or volatility.
• OTM Options: Primarily used in speculative trades due to their low cost and potential for high returns if they move ITM. However, these are higher risk, as they can expire worthless if the market doesn’t move as anticipated.

Conclusion

Understanding terms like its complete form in trading, OTM meaning, and at-the-money option can help you make informed decisions. In-the-money and out-the-money option classifications help traders determine the potential profit or loss from options based on the difference between the strike price vs. the spot price. Whether choosing ITM options for stability, ATM options for balance, or OTM options for high-risk speculation, each offers unique advantages and challenges.

Options trading offers flexibility, but risks are always involved. The right choice depends on individual goals, market outlook, and risk tolerance, making options a versatile but complex area in financial markets.

Frequently Asked Questions – FAQs

1. What does OTM stand for in options trading?

OTM stands for “out of the money.” An out-of-the-money option has a strike price that is unfavorable to the current market price of the underlying asset.

2. When is a call option considered ITM?

A call option is in the money (ITM) when the strike price is below the current market price of the underlying asset. This allows the holder to buy the asset at a lower price than its market value.

3. What does it mean when a put option is ATM?

When a put option has a strike price that is very close to or equal to the current market price of the underlying asset, it is considered at the money (ATM). In this case, there is little to no intrinsic value to the option.

4. How can an OTM call option become profitable?

An out-of-the-money call option can become profitable if the price of the underlying stock rises high enough above the strike price to offset the premium paid for the option. This allows the holder to buy the stock at the lower strike price and sell it for a net profit.

5. Why are OTM options cheaper than ITM options?

OTM options have no intrinsic value, only time value. ITM options have intrinsic value due to their favourable strike price an,d therefore cost more upfront. Traders pay less premium for OTM options.

Author: All Content is verified by SMC Global Securities.