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Strategies for success with at the money trading strategies

09 Feb 2024

Introduction

Options with a strike price equal to the current market price of the underlying stock are known as 'at-the-money' (ATM) options. These options do not possess intrinsic value, but they have time value, which means they may have the potential to generate profits before their expiration.

In this blog, let us understand what at-the-money call options are and how they work.

What are at-the-money call options?

At-the-money options refer to options whose strike prices align precisely with the current market price of the underlying stock. The term 'moneyness' describes the relationship between the option's strike price and the underlying stock's price, categorised as 'in the money,' at the money,' or 'out of the money'.

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Imagine you have a call option for XYZ Ltd. at a strike price of Rs. 1,000 and a current market price of Rs. 1,200 

If the strike price of your call option is Rs.1,000, and the current market price of XYZ stock is Rs.1,200, your call option is in-the-money. Your option has an intrinsic value of Rs.200 (1,200 - 1,000).

Suppose your call option's strike price is Rs.1,300, but the market price of XYZ stock remains at Rs 1,200. In this case, your call option is out of the money. It doesn't make sense to exercise the option because you'd be buying the stock for Rs 1,300 through the option when it's available for Rs1,200 in the market. This option has no intrinsic value.

If your call option has a strike price of Rs.1,200, and the market price of XYZ stock is also Rs.1,200, your call option is considered at the money. This option doesn't have intrinsic value, but it may have time value, depending on factors like volatility and the time left until expiration.

Options are contractual agreements that grant the buyer the privilege, but not the obligation, to purchase (in the case of a call option) or sell (in the case of a put option) a stock at a predetermined strike price on or before a specified date.

At-the-money options in a straddle

At-the-money options are used in an options trading strategy known as the "straddle." In a straddle, the trader acquires both at-the-money calls and put options, each about the same stock, featuring an identical strike price and expiration date. The underlying premise of this strategy revolves around speculating on a substantial price movement, either in an upward or downward direction.

To illustrate this concept, let's consider the scenario of a company whose stock is currently trading at Rs 2000 with an upcoming earnings announcement. In this context, a trader establishes a straddle position by procuring at-the-money call and put options, both with a strike price of Rs.2000, each carrying a price tag of Rs.200. For the trader to realise a profit, the stock's price must change by Rs.400 per share, equivalent to the combined cost of both options.

At first glance, this strategy may appear relatively straightforward, as it seemingly offers the potential for profit in both rising and falling market scenarios. However, its implementation can be tough in the actual world of trading. Notably, heightened market volatility tends to result in elevated option prices, making it more challenging to secure a profit. As with all trading decisions, the effectiveness of purchasing a straddle relies on well-timed execution and is subject to judgment.

At-the-money options in a covered call strategy

In the covered call strategy, stock owners sell at-the-money call options, offering the potential for added earnings. When the purchaser of the call option decides to exercise it, the seller is obligated to sell their stock at the predetermined strike price. However, if the option expires without being exercised, the seller makes a profit by retaining the premium received.

When opting to sell a call option, its position about the current stock price matters. Selling an in-the-money call results in a higher premium, but it also risks being forced to sell the stock at a lower price if the option is exercised. Selling an out-of-the-money call reduces the likelihood of exercise but offers a lower premium. At-the-money calls between these two extremes present an appealing balance, offering attractive premiums while also having a lower probability of being exercised.

In conclusion, at-the-money (ATM) options have both time and potential value. They are used in strategies like the straddle and covered call, offering opportunities in various market conditions. Timing and judgment are crucial, as market volatility can affect option prices. Traders should exercise caution when trading in ATM options.

 

Related Articles: How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account | Factors to Consider When Opening a Demat Account 

 

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