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 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 investor purchases a put option for $ 97 strike price (Contract Price) and if the market value of stock in 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 contract period investor to check whether exercising an option is beneficial or not by comparing the price with the market price.
#2 – Put Option
A put option is referred to as a sale option. When the price in the open market is higher than 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 case of out the money option 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 strike price i.e. contract price. it has to purchase from the open market when the call option expires in out the money the buyer loses his right to purchase at pre-determined price because of this 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 put option expires seller is no longer able to sale at strike price it has to sell at market price so there are chances that market price is lower than the strike price so the seller will lose the benefit as well as 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 option 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 option 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 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 –
