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Lesson 3:

‘Moneyness’

In-the-money, at-the-money, out-of-the-money

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Your option can be in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM). These terms indicate the intrinsic value of the option, not necessarily your profit or loss. 'Moneyness' essentially tells us whether there is any inherent value in exercising the option based on the current price of the underlying asset. The moneyness of an option doesn't directly equate to profitability—it simply tells us if there's value in exercising the option at the current market price. It answers the question, does the option contain executable value?

Lesson 3: ‘Moneyness’ -- In-the-money, at-the-money, out-of-the-money

With our continuing call option example, let's break down what each term means:

options example

In-the-Money:

For a call option, this means that the current price of the underlying asset is above the strike price of the option. If you were to exercise this option, you'd be able to buy the asset at a price lower than the current market value.

arrow   If XYZ's stock is currently trading at $110 per share, our call option to buy at $100 is attractive because it allows us to purchase the stock for less than its market value. This makes our option 'in-the-money' (ITM) since the strike price is more favorable than the market price by $10 per share—the difference is known as the option's intrinsic value. This contract contains executable value.

Lesson 3: ‘Moneyness’ -- In-the-money, at-the-money, out-of-the-money

With our continuing call option example, let's break down what each term means:

options example

At-the-Money:

This is when the current price of the underlying asset is equal to the option's strike price. While there's no intrinsic value in exercising the option at this point, it's on the cusp of being either profitable or not.

arrow   In a scenario where XYZ is trading exactly at the strike price of $100, the option is said to be 'at-the-money' (ATM). An at-the-money option means the strike price and market price are the same, and while there's no intrinsic value, the option could still have extrinsic value based on time left until expiration and market volatility.

Lesson 3: ‘Moneyness’ -- In-the-money, at-the-money, out-of-the-money

With our continuing call option example, let's break down what each term means:

options example

Out-of-the-Money:

For a call option, being out-of-the-money means the current price of the underlying asset is below the strike price. Exercising this option would not be beneficial, as you'd be paying more than the market value.

arrow   Conversely, if XYZ's share price dropped to $95, our call option would be 'out-of-the-money' (OTM). Exercising the option to buy at $100 is not favorable since the stock is available on the market for $5 less. In this case, the option is out-of-the-money by $5 per share, which is the amount by which the strike price exceeds the market price.

Remember, while 'moneyness' indicates the intrinsic or executable value of an option, it does not automatically translate to profit because we must also consider the premium paid for the option.

Lesson 3: ‘Moneyness’ -- In-the-money, at-the-money, out-of-the-money

Key Takeaways

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1. The 'moneyness' of an option indicates whether exercising the option has inherent financial benefit, known as intrinsic value.

2. A call option is 'in-the-money' (ITM) when the current market price of the underlying asset is higher than the option's strike price, giving it positive intrinsic value.

3. A put option is 'in-the-money' when the current market price of the underlying asset is lower than the option's strike price, also giving it positive intrinsic value.

4. Options are 'at-the-money' (ATM) when their strike price is equal to the current market price of the underlying asset, meaning they have no intrinsic value but may still hold potential due to time value or volatility.

5. Any option that lacks intrinsic value, meaning the strike price is not favorable compared to the market price, is considered 'out-of-the-money' (OTM).

Click “NEXT” to check your knowledge

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Lesson 3:

Knowledge Check

Lesson 3: ‘Moneyness’ -- In-the-money, at-the-money, out-of-the-money

Knowledge Check

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What determines if a call option is 'in-the-money' (ITM)?

(Select an answer below)

Lesson 3: ‘Moneyness’ -- In-the-money, at-the-money, out-of-the-money

Knowledge Check

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An XYZ call option with a strike price of $100 is said to be 'at-the-money' (ATM). What does this imply about the current market price of XYZ shares?

(Select an answer below)

Lesson 3: ‘Moneyness’ -- In-the-money, at-the-money, out-of-the-money

Knowledge Check

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If an investor has purchased a call option with a strike price of $100 and the current market price of the stock is $95, how is the option classified?

(Select an answer below)

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Congratulations!

You have completed The Foundation - Lesson 3:

‘Moneyness’ -- In-the-money, at-the-money, out-of-the-money

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