Understanding “Moneyness” in Options Trading
Moneyness is a term describing the relationship between the strike price of an option and the current trading price of its underlying security.
In options trading, terms such as in-the-money, out-of-the-money and at-the-money describe the moneyness of options.
A call option is in-the-money when its strike price is below the current trading price of the underlying asset. A put option is in-the-money when its strike price is above the current trading price of the underlying asset.
In-the-money options are generally more expensive as their premiums consist of significant intrinsic value on top of their time value.
Calls are out-of-the-money when their strike price is above the market price of the underlying asset. Puts are out-of-the-money when their strike price is below the market price of the underlying asset.
Out-of-the-money options have zero intrinsic value. Their entire premium is composed of only time value. Out-of-the-money options are cheaper than in-the-money options as they possess greater likelihood of expiring worthless.
An at-the-money option is a call or put option that has a strike price that is equal to the market price of the underlying asset.
Like OTM options, ATM options possess no intrinsic value and contain only time value which is greatly influenced by the volatility of the underlying security and the passage of time.
Which one should you buy and which one should you sell?
If you like buying, I suggest ITM (In the money) because options tend to have more intrinsic value, which makes their value increase more then the other two choices ATM and OTM when the stock price rises. Plus their higher intrinsic value from being in the money means their value doesn’t drop as quickly as at the money or out of the money options when the price of the underlying asset falls. So if you want to buy options, I recommend ITM options.
If you are selling options I recommend OTM options because they have no intrinsic value and are completely extrinsic value, which is all time value. This means their price falls each day, so they become cheaper to buy back every day you wait. Also OTM options are much farther from the current market then ITM and ATM options, so the likelihood of the stock reaching their strike price is very low. So your chance of a successful trade is better.
✍🏼 by Shortsegments.
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