A:

Stock options, whether they are put or call options, can become very active when they are at the money. In the money options refer to when the strike price of a call option is below the market price of the underlying stock, and when the strike price of a put option is above the market price of the underlying stock.

At the money means that the strike price is right at the underlying stock's current market price. The activity of options generally increases as the option approaches the declaration date and when the option is at the money.

Options can be used in one of two ways: to hedge against price changes and to speculate on the future market prices of underlying securities. The activity of options while they are at the money may be based on either of these reasons.

Hedging activity usual involves institutional investors. Option trading activity when an option is at the money may mean that the investing institution is taking a married position and hedging against small changes in the stock's market price. For example, assume a hedge fund purchases shares in ZXC Corp. for $35 dollars per share. Twelve months later, ZXC's stock is worth $45 per share. The hedge fund can purchase put options with a strike price of $45, and does so because the fund wants to "guarantee" that the price for which it sells its stock is $45. With this scenario, the fund locks in the return it can get by taking the married put with ZXC stock.

In a speculative situation, an investor believes he can predict an option's underlying stock's price into the future. By purchasing an option that is currently out of the money, there will be a gain if the stock's market price moves in the right direction. For example, assume that an investor purchases a call option for the same company as above (ZXC Corp.) for $1.50 per contract with a strike price of $45; the option is out of the money. The investor waits for 12 months, betting that the stock's price will increase from $35 to more than $45. After the same 12-month period, the stock's price increases to $45, and the option is worth $3.50 per contract. In this scenario, the investor is speculating that the stock price of ZXC will increase over time, and that he will make money on the call option.

To learn more, read our Options Basics Tutorial or The Four Advantages Of Options.

RELATED FAQS
  1. How does a forward contract differ from a call option?

    Forward contracts and call options are different financial instruments that allow two parties to purchase or sell assets ... Read Full Answer >>
  2. Why do companies enter into futures contracts?

    Different types of companies may enter into futures contracts for different purposes. The most common reason is to hedge ... Read Full Answer >>
  3. How can I hedge my portfolio to protect from a decline in the food and beverage sector?

    The food and beverage sector exhibits greater volatility than the broader market and tends to suffer larger-than-average ... Read Full Answer >>
  4. What are common delta hedging strategies?

    The term delta refers to the change in price of an underlying stock or exchange-traded fund (ETF) as compared to the corresponding ... Read Full Answer >>
  5. What techniques are most useful for hedging exposure to the insurance sector?

    Investing style determines the best hedging techniques for the insurance sector. This sector comprises three segments, two ... Read Full Answer >>
  6. How do I determine the breakeven point for a short put?

    The breakeven point for a short put is the strike price of the option minus the premium. Selling puts is a way for traders ... Read Full Answer >>
Related Articles
  1. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  2. Technical Indicators

    Using Moving Averages To Trade The Volatility Index (VIX)

    VIX moving averages smooth out the natural choppiness of the indicator, letting traders and market timers access reliable sentiment and volatility data.
  3. Forex Strategies

    How To Avoid Exchange Rate Risk

    What are the best strategies to avoid exchange rate risk when trading?
  4. Home & Auto

    When Getting a Rent-to-Own Car Makes Sense

    If your credit is bad, rent-to-own may be a better way to purchase a car than taking out a subprime loan – or it may not be. Get out your calculator.
  5. Investing Basics

    Explaining Forward Rate Agreements

    Forward rate agreement (FRA) refers to an interest rate or foreign exchange hedging strategy.
  6. Options & Futures

    An Introduction To Value at Risk (VAR)

    Volatility is not the only way to measure risk. Learn about the "new science of risk management".
  7. Mutual Funds & ETFs

    Currency-Hedged ETFs: Should You Invest?

    Currency-hedged ETFs offer many more pros than cons when compared to their counterparts, but there is still one big con.
  8. Investing

    Looking To Begin Trading In The Stock Market?

    If you are a new trader, we explain the differences between penny stocks and options so you can make the best decision for your personal trade plan.
  9. Options & Futures

    How to Trade Options on Government Bonds

    A look at trading options on debt instruments, like U.S. Treasury bonds and other government securities.
  10. Forex Strategies

    Forex or Stock Trading: Which Works For You?

    Even though the odds favor stock trading, forex trading has several advantages to offer a particular type of investor.
RELATED TERMS
  1. Derivative

    A security with a price that is dependent upon or derived from ...
  2. Security

    A financial instrument that represents an ownership position ...
  3. Series 6

    A securities license entitling the holder to register as a limited ...
  4. Internal Rate Of Return - IRR

    A metric used in capital budgeting measuring the profitability ...
  5. Board Of Directors - B Of D

    A group of individuals that are elected as, or elected to act ...
  6. Strike Width

    The difference between the strike price of an option and the ...

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!