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Market Structure

Out of the Money (OTM)

An option with no intrinsic value. Its price comes entirely from time value and the chance the stock moves before expiration.

What does "out of the money" mean?

An option is "out of the money" (OTM) when it has zero intrinsic value. Exercising right now would be pointless, so its entire premium is time value.

  • A call is OTM when the stock price is below the strike price. There is no point buying at the strike if you can buy cheaper on the open market.
  • A put is OTM when the stock price is above the strike. There is no point selling at the strike if you can sell higher on the open market.

Why OTM options are cheap

OTM options rely entirely on the stock moving far enough to become in the money before expiration. That is uncertain, so the market prices them at a discount. The further from the current price, the cheaper and the less likely to pay off.

The far-OTM trap

$0.05 and $0.10 options look tempting because a small budget buys a lot of contracts. These almost always expire worthless. For every nine losses you need one 10x winner just to break even, and most traders do not get the winner often enough. Stay near the money early on.

Related Terms

At the Money (ATM)

An option whose strike price is roughly equal to the current stock price. Has the most extrinsic value of any strike.

In the Money (ITM)

An option with real value right now. A call is ITM when the stock is above the strike; a put is ITM when the stock is below.

Intrinsic Value (Options)

The portion of an option's price that comes from the stock already being past the strike. Zero for out-of-the-money options.

Options

Contracts that give the buyer the right, but not the obligation, to buy or sell a stock at a specific price before a specific date.