Definition
In finance, “Out of the Money” (OTM) refers to an option that wouldn’t profit if it were exercised immediately. For call options, this is when the strike price is higher than the current market price of the underlying asset. For put options, it’s when the strike price is lower than the market price.
Key Takeaways
- ‘Out of the Money’ (OTM) is a term used in options trading to describe a situation where the strike price for a call option is above the current market price of the underlying asset. Alternatively, for a put option, it signifies that the strike price is lower than the current market price of the asset.
- Buying an OTM option is a high-risk, high-reward strategy. Although such options are cheaper to purchase because they don’t have intrinsic value, they require a substantial move in the price of the underlying asset to become profitable.
- The value of an OTM option is purely based on its time value and volatility of the underlying asset since it does not have any intrinsic value. It means, if the underlying asset’s price doesn’t move towards the strike price before expiration, the option might expire worthless.
Importance
The finance term “Out of the Money” (OTM) is important because it plays a crucial role in options trading. It describes an option that doesn’t have any intrinsic value, meaning an option that would not be profitable if it were exercised immediately.
Put options are OTM when the underlying asset’s price is higher than the strike price, while call options are OTM when the underlying asset’s price is lower than the strike price. Its significance lies in its potential to create strategic opportunities for investors.
While OTM options may seem worthless, they can be inexpensive to purchase and carry potential for substantial profits if the market conditions shift favorably. As such, understanding and strategically using OTM can prove to be a crucial investment strategy.
Explanation
The financial term “out of the money” (OTM) is primarily used in the world of options trading, and it delves into the purpose of evaluating the relative positioning and potential of a particular options contract. Essentially, it refers to an options contract that lacks intrinsic value given the relationship between its strike price and the current price of the underlying asset. This term plays a crucial role in defining the risk and potential rewards associated with options trading.
The main purpose of denoting an option as being “out of the money” is to inform traders of the options’ current status and future potential. For call options, an OTM status means that the strike price currently is higher than the market price of the underlying asset. For put options, an OTM position denotes that the strike price is less than the market price of the underlying asset.
This term is significant because it helps investors assess whether or not it would be profitable to exercise the option. While OTM options aren’t enticing to exercise at the current moment due to the lack of intrinsic value, they may still hold potential for future profitability should the market move favorably. The OTM term, thus, serves as a vital risk management tool, offering investors a clear picture of where the option stands relative to the market situation.
Examples of Out of the Money
“Out of the Money” (OTM) is a finance term used in options trading. An option is said to be out of the money if the strike price of the option is not favorable compared to the current market price of the underlying asset. Here are three real-world examples:Stock Options: Consider a call option for Apple Inc. stock with a strike price of $
If the current market price of Apple Inc. stocks is $145, then the call option is said to be out of the money, because buying the stock directly from the market is cheaper than exercising the option.Currency Exchange Options: Suppose you own a USD/EUR call option having a strike price of
20 and the current market exchange rate is15 USD/EUR. This means your option is out of the money because you could exchange your dollars for Euros at a better rate in the open market than exercising the option.
Commodity Options: Let’s assume you have a crude oil put option with a strike price of $60 per barrel. If the current market price is $65 per barrel, then your put option is out of the money, as selling the oil directly in the market would fetch a higher price compared to selling it using the put option.
“`html
FAQ Section: Out of the Money
What does ‘Out of the Money’ mean in finance?
Out of the money (OTM) is a term used in finance and investing to describe a financial contract like an option, that doesn’t have any intrinsic value. In other words, the contract is OTM when it wouldn’t be profitable to exercise it.
When is an option considered ‘Out of the Money’?
A call option is Out of the Money when its strike price is higher than the current market price of the underlying asset. Conversely, a put option is Out of the Money when its strike price is lower than the current market price of the underlying asset.
Does ‘Out of the Money’ mean the option is worthless?
No, an Out of the Money option is not necessarily worthless. While it may have no intrinsic value, it may still have time value prior to expiry, which could provide profit if the underlying asset moves in the desired direction.
What happens when my option expires ‘Out of the Money’?
If an option expires Out of the Money, it becomes worthless and the trader loses the amount of the premium that they paid for it.
“`
Related Entrepreneurship Terms
- Strike Price
- Option Premium
- In the Money
- Put Option
- Call Option
Sources for More Information
- Investopedia – A comprehensive source for unbiased financial education resources and investing terms.
- The Free Dictionary’s Financial Dictionary – It provides a detailed explanation about different financial terms, including “Out of the Money”.
- MarketWatch – Features finance news and analysis articles with a section dedicated to understanding investing and trading terms.
- Canadian Couch Potato – A reliable source on investing strategies, including background on various financial terms.
