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DEFINITION of 'Underwater'

An option that would be worthless if it expired today. An underwater option may be either a call or put option. A call option is underwater when its strike price is higher than the market price of the underlying asset. A put option is underwater when its strike price is lower than the market price of the underlying asset. An option's value is determined by its intrinsic value, time to expiration, volatility and the underlying asset's current value.

BREAKING DOWN 'Underwater'

An underwater option is also known as an "out of the money option." These options are less expensive to purchase but are considered riskier because they are more likely than in-the-money options to expire worthless. A trader might choose to buy underwater options if he had little capital to invest or if he expected a significant move in the underlying asset's price.

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