Out Of The Money - OTM

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What is 'Out Of The Money - OTM'

Out of the money (OTM) is a call option with a strike price that is higher than the market price of the underlying asset, or a put option with a strike price that is lower than the market price of the underlying asset. An out of the money option has no intrinsic value, but only possesses extrinsic or time value. As a result, the value of an out of the money option erodes quickly with time as it gets closer to expiry. If it still out of the money at expiry, the option will expire worthless.

BREAKING DOWN 'Out Of The Money - OTM'

For example, consider a stock that is trading at $10. For such a stock, call options with strike prices above $10 would be out of the money calls, while put options with strike prices below $10 would be out of the money puts. Out of the money options are significantly cheaper than in the money or at the money options, and offer the biggest leverage or bang for the buck if the option trader's view proves to be correct.

In the case of a stock that is trading at $30, a one-month call with a $29 strike may be priced at $1.50, while a one-month call with a $31 strike may be priced at 40 cents. If the stock appreciates to $31 by option expiry, the $29 call would be trading at about $3.00, while the $31 call would be priced around $1.00. In this case, the gross return of 150% for the $31 call is well above the 100% return for the $29 call.

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RELATED FAQS
  1. What is the difference between in the money and out of the money?

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  2. How does the term 'in the money' describe the moneyness of an option?

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  3. How are call options priced?

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  4. What happens when a security reaches its strike price?

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  5. Where did the terms in-the-money and out-of-the-money come from?

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