Introduction
Options trading can be a bit tricky for beginners, but understanding the terms ITM (In-the-Money), ATM (At-the-Money), and OTM (Out-of-the-Money) is essential to making smart decisions in the stock market. These terms help investors know whether their options contracts are profitable, and they can help guide trading strategies. In this blog, we will explain what these terms mean, how they affect trading, and how they apply to call and put options.
What are ITM, ATM, and OTM?
In options trading, ITM, ATM, and OTM describe the relationship between the option's strike price (the price at which the option holder can buy or sell the underlying stock) and the market price of the stock.
-
In-the-Money (ITM): This is when the option has intrinsic value. It means the option is profitable if exercised immediately.
-
At-the-Money (ATM): This is when the strike price of the option is the same as the market price of the underlying stock.
-
Out-of-the-Money (OTM): This is when the option does not have intrinsic value and would not make a profit if exercised immediately.
Understanding these terms will help traders make more informed decisions and manage risk.
Open your Trading Account today!
Call Options
A call option gives the holder the right to buy a stock at a specific price (called the strike price) before a certain date (called the expiry date).
In-the-Money Call Option
An In-the-Money (ITM) call option is when the strike price is lower than the current market price of the stock. This means that the option holder can buy the stock for less than its market value, thereby making a profit. For example, if the market price of a stock is ₹200 and the strike price is ₹180, the call option is ITM and has an intrinsic value of ₹20.
At-the-Money Call Option
An At-the-Money (ATM) call option is when the strike price is exactly equal to the current market price of the stock. In this case, the option has no intrinsic value, and it’s essentially a break-even point. For example, if the stock price is ₹200 and the strike price is also ₹200, the call option is ATM. There’s no immediate profit or loss from exercising the option.
Out-of-the-Money Call Option
An Out-of-the-Money (OTM) call option is when the strike price is higher than the current market price of the stock. This means the option has no intrinsic value, and it wouldn’t make sense to exercise it because the stock can be bought for cheaper on the open market. For example, if the stock price is ₹200 and the strike price is ₹220, the call option is OTM, meaning the option is not profitable at the moment.
Put Options
A put option gives the holder the right to sell a stock at a specific price before the expiry date.
In-the-Money Put Option
An In-the-Money (ITM) put option is when the strike price is higher than the current market price of the stock. This means the option holder can sell the stock for more than its market value, thereby making a profit. For example, if the stock price is ₹150 and the strike price is ₹170, the put option is ITM and has an intrinsic value of ₹20.
At-the-Money Put Option
An At-the-Money (ATM) put option is when the strike price is exactly equal to the market price of the stock. In this case, there’s no profit or loss from exercising the option. For example, if the stock price is ₹200 and the strike price is also ₹200, the put option is ATM. It’s a break-even situation for the trader.
Out-of-the-Money Put Option
An Out-of-the-Money (OTM) put option is when the strike price is lower than the current market price of the stock. This means the option has no intrinsic value and wouldn’t be profitable if exercised. For example, if the stock price is ₹200 and the strike price is ₹180, the put option is OTM, meaning it’s not worth exercising because the stock can be sold for a higher price in the open market.
Difference Between ITM, ATM, and OTM Options
The main differences between ITM, ATM, and OTM options lie in the relationship between the strike price and the current market price. Here’s a simple comparison:
Why Traders Analyse ITM, ATM, and OTM
Traders analyse whether options are ITM, ATM, or OTM to make informed decisions about buying or selling options. These factors help traders understand whether an option is profitable or not and if they should exercise it.
For example, ITM options are usually more expensive because they have intrinsic value. ATM and OTM options are cheaper, but they also come with more risk since they are less likely to be profitable. Understanding these types helps traders manage their risk and make better choices based on the market.
Options: Long and Short and Example
In options trading, you can either take a long position or a short position.
-
Long Position: When you buy an option, you are taking a long position. You expect the market price to move in your favor, so you can make a profit.
-
Short Position: When you sell an option, you are taking a short position. You expect the market price to move against the holder of the option, which will make your position profitable.
For example, if you think a stock’s price will rise, you buy a call option (long position). If you think the stock’s price will fall, you buy a put option (short position).
Long Position Profits and Cons vs Short Position Profits and Cons
Here’s a comparison of the pros and cons of long and short options positions:
Understanding ITM, ATM, and OTM options is crucial for anyone involved in options trading. By knowing the differences between these types and understanding the benefits and risks, traders can make more informed decisions. Whether you’re looking to buy or sell options, it’s essential to know how these terms affect your trade. Stay informed, manage your risk, and trade wisely for success in the options market.