Understanding Options Terminology – Part 2/2
This is Part 2/2 of Understanding Options Terminology:
4. ITM – In the money
In-the-money (ITM) refers to an option (call or put) that has some intrinsic value.
A call option is said to be ITM when the strike price < price of the underlying. For example, when the underlying is at $60, a 55 strike call is said to be ITM because it has $5 of real value. The real value exists because you can buy the underlying stock at $55 when the market value is $60.
A put option is said to be ITM when the strike price > price of the underlying. For example, when the underlying is at $60, a 65 put option is said to be ITM because it has $5 of real value. The real value exists because you can sell the underlying stock at $65 when the market value is only $60.
5. ATM – At the money
An option (call or put) is said to be at-the-money (ATM) when the strike price is approximately equal to the price of the underlying. For example, a 55 put strike is said to be ATM when the underlying is at $~55.
6. OTM – Out of money
Out-the-money (OTM) refers to an option (call or put) that has NO intrinsic value, but ONLY contains “time” value or extrinsic value.
Options can be ITM, ATM or OTM at any given time because this relationship depends on the price of the underlying to the options’ strike price. For example, RIMM was trading for ~$86 before earnings were announced on Sep 09 and all call options (strikes) below $86 were ITM (i.e. 85 call strike, 80 call strike, etc) as their contained “real” value. However, after the earnings announcement, the stock dropped to ~$69 and many of the ITM options (85 call strike) were either now ATM or OTM – these options had lost all their “real” value after earnings announcement.
Another way to determine if an option is ITM, ATM or OTM is to just look at the options price. ITM options will be greater in value than ATM options, which will be greater in value than OTM options. ITM $ > ATM $ > OTM $
Click here to read Understanding Options Terminology – Part 1/2.
