Understanding the Moneyness of a of a call option - Motilal Oswal
Understanding the Moneyness of a of a call option - Motilal Oswal

# Understanding the Moneyness of a call option

A popular term pertaining to options is the moneyness of the option. The moneyness of an option is basically a determinant of whether the particular option has a positive intrinsic value or an intrinsic value of zero. Remember, intrinsic value of an option can never be negative; the lowest possible intrinsic value of an option is zero. The reason moneyness of an option is important is that it determines whether the option is valuable or not. To understand moneyness we first need to understand the concept of intrinsic value of an option. Let us look at moneyness of a call option in this case. Let us also look at the moneyness of options and the larger concept of moneyness in options..

Intrinsic value of a call option
As we are aware, a call option is a right to buy an underlying asset without the obligation to buy. So the buyer of the call option gets the right to buy without the obligation to buy. The seller of the call option has an obligation to sell at the agreed price and on the agreed date. Since the seller of the call option gives an unfettered right to the buyer of the option, he will charge him a price for this right. The price of the right that the buyer has to pay to the seller of the call option is called the option price or the option premium.
Let us take the example of SBI with a spot price at Rs.275. The 260 call option on SBI for the March 2018 series is available at an option price of Rs.23. Now let us break up this option premium into two components.

Details of the Call OptionPrice of the Call OptionCommentSBI 260 Call (Mar 2018)Rs.23This is the price paid by the buyer for the rightIntrinsic value of the SBI call optionsRs.15
(275-260)Since the price is already Rs.15 more than strike priceTime value of the SBI call optionRs.8
(23 – 15)It is the residual value implied in the option price

As can be seen from the above example, the intrinsic value is embedded in the market price. If the spot price of SBI goes up to Rs.280, the intrinsic value of the call option becomes Rs.20. It is a positive intrinsic value that determines the moneyness of the call option and decides whether the option should be exercised or not.

3 levels of moneyness of call options (ITM, ATM and OTM)..
There are 3 types of moneyness that applies to call options. Let us consider these 3 different types of moneyness in case of the call option for SBI 260 call..

In-the-Money (ITM) Call Option: If the strike price of the SBI call is below the market price then the option becomes ITM. In the above case since spot price of SBI is Rs.275, all SBI call strikes of 270 and below will be ITM in terms of moneyness.

At-the-Money (ATM) Call Options: If the strike price of the SBI call is the same as the market price then the option becomes ATM. In the above case, the SBI call strike of Rs.275 will be ITM in terms of moneyness.

Out-of-the-Money (OTM) call option: If the strike price of SBI call is above the market price then the option becomes OTM. In the above case, all SBI call strikes of 280 and above will be OTM in terms of moneyness.

Understanding Moneyness with a call option value table..
Let us understand moneyness of the SBI call option for different strikes when the spot price of SBI is Rs.275.