Moneyness

Moneyness refers to a way to define the intrinsic value of an option in relation to its strike price and the market price of the instrument to which an option pertains. Basically, through moneyness, one would be able to determine how much an option might be worth or how much profit it possibly conceived. In essence, they will be able to make up their minds about buying, selling, or holding options. 

What is moneyness? 

Moneyness is a term used in the options market that explains how useful the perennial price of an underlying can be relative to the strike price of an option. It helps determine whether an option is located to be in a profit position. There are basically three main classes of moneyness: in-the-money (ITM), at-the-money (ATM), and out-of-the-money (OTM). An option is said to be in the money if the strike price appears to have intrinsic value given the prevailing market price of the underlying asset—in other words, the options trader would realize a positive payoff if he chose to exercise the options. An at-the-money option occurs if the exercise price is close to the prevailing market price of the underlying, thereby having no intrinsic value but could have some appreciation with the passage of time. Out-of-the-money options, they do not have intrinsic value because the call’s strike price is higher than the asset’s current value, while the put’s strike price is lower. Each affects the value of the option and the strategy used. 

Understanding Moneyness 

Understanding the moneyness helps identify the three potential states of an option. In-the-money (ITM) means intrinsic value; the underlying price has moved above the strike price in terms of a call, so it is profitable. For a put, the price is below the strike. ITM options are attractive but tend to be higher priced, with their premium floating from their intrinsic values. 

At-the-money is due to the proximity of a strike price to an asset’s current price. Thus, all ATM options have no intrinsic value but can carry significant time value for those traders hoping to take advantage of volatility or a specific strategy. 

Types of Moneyness 

Moneyness is the most significant concept when it comes to pricing options and options strategy. Let’s take a closer look: 

In-the-Money (ITM): A call option is said to be ITM when the holder can buy the underlying asset at an exercise price lower than the prevailing market price. A put option is ITM if it provides the holder with the right to sell the asset at an execution price higher than the market price. The ITM option will be more expensive because it now contains intrinsic value, meaning profit upon execution. 

At-the-Money: Options priced at the market price of the underlying product. Interestingly, ATM options are comparatively cheaper than ITM options and more expensive than OTM options because of their time value. A market participant can add ATM options when executing straddle or strangle options strategies while witnessing a major price movement in any direction. 

Out-of-the-money: They cost less compared to the in-the-money options since they do not display any value. They are comprised purely of extrinsic value. They are speculative and used by people dealing with speculation in case of such a price change. Out-of-the-money options, although cheaper than in-the-money options, will have more chances of expiring worthless or negatively for the holder, as for an option to be in the money, a high-magnitude move by the underlying asset would be required to realise a profit. 

Impact of Moneyness 

Moneyness is one of the key factors influencing option prices and, consequently, trading strategies. The value of an option is known as a premium, which is a function of money. 

Options ITM: In-the-money options possess a considerable amount of intrinsic and, at the same time, time value in premium. The more underlying value there is in the money, the more intrinsic value it enjoys, even though it could be the premium that ends up shooting up. Traders resorted to the use of such options when they sorely expected further changes in the price of a certain underlying. 

ATM Options: These options are at the money. The premium, therefore, is mainly comprised of time value and volatility. A value would be sensitive to volatility changes and time decay. Speculators take a trade with an At the Money option on a speculated future movement or hedge an existing position. 

OTM Options: Primarily time value and volatility-based premium; there is hardly any intrinsic value. As they are probably closer to the speculative aspect of options, OTM options are thus cheaper but more perilous. They are commonly used in those strategies that anticipate a good amount of price movement or in higher-level option strategies to take advantage of a risk limit. 

Examples of Moneyness 

Let’s take Company XYZ’s current stock price of US$50 and explain how moneyness applies in different options: 

1. In-the-Money (ITM) Call Option: You should be holding a call option on an underlying asset trading at US$50 with a strike price of US$45; then your call option is ITM, for US$50 is greater than US$45. It holds an intrinsic value of US$5-US$45 = US$5, which means it is worth US$5 if exercised. Of course, the higher that intrinsic value, the more the option is worth, and thus the higher the premium you’ll pay. 
2. At-the-Money (ATM) Call Option: You purchased a call option whose strike price is US$50, which exactly equates to the stock’s current market price. The option is thus ATM. It contains no intrinsic value but may have a premium based on time value and market expectations. These options are generally utilised when one wants to speculate on further movement or in strategies that require high sensitivity to changes in price. 
3. Out-of-the-Money Call Option: Considering that the strike price is US$55, the call option will be deemed OTM since US$55 overshoots the prevailing stock price of US$50. It does not possess intrinsic value; therefore, it only has time value and is cheaper as a result. The only way it will be gainful is if the stock price escalates to be above US$55. 

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