An option can be described by its strike price’s proximity to
the stock’s price. An option can either be in-the-money (ITM),
out-of-the-money (OTM), or at-the-money (ATM).
An at-the-money option is described as an option whose exercise
or strike price is approximately equal to the present price of
the underlying stock.
For instance, if Microsoft (MSFT) was trading at $65.00, then
the January $65.00 call would an example of an at-the-money call
option. Similarly, the January $65.00 put would be an example of
an at-the-money put option.
An in-the-money call option is described as a call whose strike
(exercise) price is lower than the present price of the
underlying. An in-the-money put is a put whose strike (exercise)
price is higher than the present price of the underlying, i.e.
an option which could be exercised immediately for a cash credit
should the option buyer wish to exercise the option.
In our Microsoft example above, an in-the-money call option
would be any listed call option with a strike price below $65.00
(the price of the stock). So, the MSFT January 60 call option
would be an example of an in-the-money call.
The reason is that at any time prior to the expiration date, you
could exercise the option and profit from the difference in
value: in this case $5.00 ($65.00 stock price – $60.00 call
option strike price = $5.00 of intrinsic value). In other words,
the option is $5.00 “in-the-money.”
Using our Microsoft example, an in-the-money put option would be
any listed put option with a strike price above $65.00 (the
price of the stock). The MSFT January 70 put option would be an
example of an in-the-money put.
It is in-the-money because at any time prior to the expiration
date, you could exercise the option and profit from the
difference in value: in this case $5.00 ($70.00 put option
strike price – $65.00 stock price = $5.00 of intrinsic value. In
other words, the option is $5.00 “in-the-money.”
An out-of-the-money call is described as a call whose exercise
price (strike price) is higher than the present price of the
underlying. Thus, an out-of-the-money call option’s entire
premium consists of only extrinsic value.
There is no intrinsic value in an out-of-the-money call because
the option’s strike price is higher than the current stock
price. For example, if you chose to exercise the MSFT January 70
call while the stock was trading at $65.00, you would
essentially be choosing to buy the stock for $70.00 when the
stock is trading at $65.00 in the open market. This action would
result in a $5.00 loss. Obviously, you wouldn’t do that.
An out-of-the-money put has an exercise price that is lower than
the present price of the underlying. Thus, an out-of-the-money
put option’s entire premium consists of only extrinsic value.
There is no intrinsic value in an out-of-the-money put because
the option’s strike price is lower than the current stock price.
For example, if you chose to exercise the MSFT January 60 put
while the stock was trading at$65.00, you would be choosing to
sell the stock at $60.00 when the stock is trading at $65.00 in
the open market. This action would result in a $5.00 loss.
Obviously, you would not want to do that.
