Out of the Money Meaning
”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.
Example
Stock trades at $ 50 and investor has the option to call (to purchase) option at $ 52 strike price. If the market value of stock closes below $ 52 and the option expires “out of money,”. The option is worthless since the buyer will lose money by exercising the option.
Similarly for put (Sale) option if the stock traded at $ 100 and the investor purchases a put option for $ 97 strike price (Contract Price) and if the market value of stock in the open market closes above $97 on the contract expiration date and the option expires then also an option is worthless as the option buyer would lose money by exercising the option.
OTM Options
There are two options “out of the money,” call option, and put option.
#1 – Call Option
A call option is referred to as a purchase option. When the price in an open market is lower than the strike price, i.e., contract price, than investors should buy the option so as to make the transaction favorable. And if at the date of the end of the contract period, the investor to check whether exercising an option is beneficial or not by comparing the price with the market price.
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#2 – Put Option
A put option is referred to as a sale option. When the price in the open market is higher than the strike price, i.e., contract price than investors shouldn’t exercise the option as it will be worthless to exercise the option and not a favorable transaction for an investor.
Out of the Money vs. In the Money
An option can be in the money option, out the money option, or at the money option. Each one affects the intrinsic value of the option.
- In the case of the money option, the stock has some intrinsic value, whereas in the case of out the money option, the stock doesn’t have intrinsic value, and it has only time value.
- In case of the in the money, a call option gives the option buyer the right to exercise shares at the strike price (contact price) if it is beneficial to do so, whereas in out the money call option gives the option whether to exercise the transaction or not to exercise the option.
- Out the money options will give the larger gains/ losses as compared to in the money option.
- In case of the in the money option, option gives the buyer the right to purchase the asset at the strike price, i.e., contract price on or before a particular day, whereas in out the money option buyer has the option to exercise the option before the expiry of the contract date.
When Call Option Expires Out Of the Money?
The call option expires when the contract or the period for which a buyer has entered into the option agreement expires. When the call option expires in out of money, the buyer no longer is able to purchase at the strike price, i.e., contract price. It has to purchase from the open market when the call option expires in out the money, and the buyer loses his right to purchase at a pre-determined price. Because of this, the buyer may lose the benefit and premium which the buyer paid.
When Put Option Expires Out of the Money?
Similarly, the put option expires when the period of the contract expires. When the put option expires, the seller is no longer able to sell at the strike price. It has to sell at market price, so there are chances that the market price is lower than the strike price, so the seller will lose the benefit as well as the premium, which is paid at the time of buying the option.
Advantages
Some of the advantages are provided and discussed as follows-
- In out of money option stock has no intrinsic value
- OTM option gives importance to the time value of money.
- The cost of purchase is lower than in the money option.
- It involves calculative risk as compared to other options.
Disadvantages
Some of the disadvantages are provided and discussed as follows-
- It depends upon market predictions; hence chances of loss are more if prediction goes wrong.
- The risk from investor’s points of view as chances of losing.
- Suitable only for experienced options traders.
Conclusion
”’Out of the money” is used in the options market under this option underlying asset has no intrinsic value. At the end of the options expiration investor has the option to whether the exercise the option or lapse the option by calculating risk and benefit from exercising or lapsing.
Out the money option is usually low in the cost than an in-the-money option. In, in-the-money option, there is an intrinsic value of an underlying asset. It is based on market predictions hence suitable only for experienced traders.
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This has been a guide to “Out of the Money” and its meaning. Here we discuss examples, options, and when call & put option expires out of money along with advantages and disadvantages. You may learn more about financing from the following articles –
