Out-of-the-Money (OTM Options)

Definition

The term out-of-the-money refers to an option that has no intrinsic value.  The concept of moneyness helps an investor to understand the position of an underlying asset relative to an option's strike price.

Explanation

When an investor holds an option they are provided with the right, but not an obligation, to buy or sell the underlying asset at the strike price on or before the contract's expiration date. In the case of a call option, the holder has the right to buy the underlying asset, while a put option confers the right to sell the underlying.

An option that is out-of-the-money (OTM) has an exercise price that is higher, or lower, than the current market price of the underlying asset.  An option that is out-of-the-money will trade at a premium that accounts only for the time value of the option itself, since the holder would realize a loss on the transaction if they were to exercise their option to buy or sell the underlying asset.  When discussing standard options, there are two scenarios in which the contract would be out-of-the-money:

  • Put Options:  If the strike price of the put option is less than the current market price of the underlying security or asset, then that option is said to be out-of-the-money.  If the holder of the put purchased the asset at market and exercise their right to sell it at the contract's strike price, they would lose money on the transaction.
  • Call Options:  If the strike price of a call option is greater than the current market price of the underlying security or asset, then that option is said to be out-of-the-money.  If the holder of the call exercised their right to buy the asset at the contract's strike price, and then sell the asset at market, they would lose money on the transaction.

The only value an out-of-the-money option has is a function of time.  Over time, an OTM option could go in-the-money.  However, as the time to expiration approaches, the premium for an option that remains out-of-the-money will approach zero.

Related Terms

margin, maintenance margin, initial margin, lambda, kappa, deep out-of-the-money, near-the-money