At The Money Definition
At the money (ATM) is a situation wherein if the option holder exercises the option, it will result in neither loss nor gain because the exercise price or strike price is equal to the current spot price of the underlying security.
Explanation
- When an option is purchased, the buyer gets three situations, i.e., In the moneyIn The MoneyThe term "in the money" refers to an option that, if exercised, will result in a profit. It varies depending on whether the option is a call or a put. A call option is "in the money" when the strike price of the underlying asset is less than the market price. A put option is "in the money" when the strike price of the underlying asset is more than the market price.read more, At the money, and the Out of the money. These three situations vary from the point of view of the buyers as well as sellers of the option. Whenever an option is purchased at that time, there are two parties one is the buyer of the option, and another one is the seller of the option.
- Also, there are two types of buyer Call buyers and Put buyers. When the exercise price of the option is greater than the market price, the situation is out of money for the call buyers, and the situation is in the money for the put buyers.
- When the exercise priceExercise PriceExercise price or strike price refers to the price at which the underlying stock is purchased or sold by the persons trading in the options of calls & puts available in the derivative trading. Thus, the exercise price is a term used in the derivative market.read more of the option is equal to the market price, the situation is called as ATM for both the call buyer as well as the put buyer of the option, and when the exercise price of the option is less than the market price, the situation is called as in the money for the call buyer and out of money for the put buyer of the option.
- Whenever after excising the option, the result is gain, then it is said that the option is in the money, and when an option is said to be out of money that time, the result is a loss. It is very important to relate to these three situations at the same time. In a given situation, whenever the exercise price and the market priceMarket PriceMarket price refers to the current price prevailing in the market at which goods, services, or assets are purchased or sold. The price point at which the supply of a commodity matches its demand in the market becomes its market price.read more are the same at that time, it is always the situation of ATM, and it is for both buyers as well as the seller.
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Source: At The Money (wallstreetmojo.com)
Example of At The Money
- Suppose a person has bought a one month call option at a premium of $6 with an exercise price of $40. What will be the status of the current market price will be $45, $40, $35?
- Firstly, the option premium is irrelevant here since it is considered a sunk costSunk CostSunk costs are all costs incurred by the firm in the past with no hope of recovery in the future and are not considered while making any decisions since these costs will not change regardless of the decision's outcome.read more.
- Now, when the market price is $45, which is more than the exercise price, the status will be in the money for the call buyers and out of money for the put buyer.
- When the market price is $40, which is equal to the exercise price, the status will be ATM for the call buyers and similar for the put buyer as well.
- When the market price is $35, which is less than the exercise price, the status will be out of the moneyOut Of The Money”Out of the money” is the term used in options trading & can be described as an option contract that has no intrinsic value if exercised today. In simple terms, such options trade below the value of an underlying asset and therefore, only have time value.read more for the call buyers and in the money for the Put Buyer.
Difference Between At The money and In The money
- When the option is ATM, the buyer or seller will have no gain any loss. On the other hand, when the optionOptionOptions are financial contracts which allow the buyer a right, but not an obligation to execute the contract. The right is to buy or sell an asset on a specific date at a specific price which is predetermined at the contract date.read more is ITM (In the Money), the result will be gain.
- In the situation of ITM (In the Money), the intrinsic value is there, but in the case of the ATM situation, there is no intrinsic value.
- If the option has an ATM situation, then the exercise price and the market price are the same; therefore, no loss or no gain situation arises. Whereas in the other option, the exercise price is less than the market price at that time, the option is said to be ITM( In the money).
Advantages
- At the money, the option has a high chance of profit-making after the expiration of the option term in comparison to the other two situations in the options pricing.
- The prices of the option have parity with the market price of the option. This makes the investor’s decision quite simple.
- In this pricing mechanism, the option is at low risk, and the risk avoider investors are free to invest in the money marketMoney MarketThe money market is a market where institutions and traders trade short-term and open-ended funds. It enables borrowers to readily meet finance requirements through any financial asset that can be readily converted into money, providing an organization with a high level of liquidity and transferability.read more.
Disadvantages
- This situation is more costly as compared to the other two pricing, which the exchange offers.
- In this type of price, the buyer and the seller are both required to pay a higher commission to enjoy the benefit of the same.
- Sometimes it becomes difficult for the investors to decide regarding the investment because they cannot identify whether the option will provide gain or loss.
- The option prices are beneficial to the investors, but they are complicated also. The ATM situation is also the same. They can confuse investors, especially if they are beginners.
- Practically this type of situation is very rare in the money market when the exercise price and the market price are the same, and no loss or no gain situation arises. Therefore this type of option pricing is rare.
Conclusion
Both the call option buyer and the put option buyer will get the same result in “at the money.” In ATM, the situation is rare in the money market, but when it prevails, it can benefit both the buyer as well as sellers. Investors should carefully analyze the price which the exchange offers. The beginner investors should take extra caution while exercising this option price since it may contain a higher cost. These options are very better options for investors who are very aggressive because they can provide a wide range of stock movements very often.
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