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What is 'Out Of The Money - OTM'

Out of the money (OTM) is term used to describe 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.

BREAKING DOWN 'Out Of The Money - OTM'

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.

The Basics of Options

For a small premium, stock options give the purchaser the right, but not the obligation, to purchase or sell the underlying stock at an agreed-upon price, known as the strike price, before an agreed-upon date, known as the expiration date.

An option to purchase stock is known as a call option, while an option to sell stock is called a put option. Therefore, a trader would purchase a call option if he expects the stock's trading price to exceed the strike price before the expiration date, as he can execute the option and profit on the difference. Conversely, a put option enables the trader to profit on a similar decline in the stock's trading price.

Because they derive their value from that of an underlying security, options are a type of financial derivative.

Out of the Money, In the Money, or At the Money

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, while the $31 call would be priced around $1. 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?

    Learn about how the difference between in the money and out of the money options is determined by the relationship between ... Read Answer >>
  2. How does the term 'in the money' describe the moneyness of an option?

    Find out what in the money means about the moneyness of call or put options and what it indicates about the relationship ... Read Answer >>
  3. How are call options priced?

    Learn how aspects of an underlying security such as stock price and potential for fluctuations in that price, affect the ... Read Answer >>
  4. When is a call option considered to be "in the money"?

    Learn about call options, their intrinsic values and why a call option is in the money when the underlying stock price is ... Read Answer >>
  5. What happens when a security reaches its strike price?

    Learn more about the moneyness of stock options and what happens when the underlying security's price reaches the option ... Read Answer >>
  6. How do I change my strike price once the trade has been placed already?

    Learn how the strike prices for call and put options work, and understand how different types of options can be exercised ... Read Answer >>
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