Option Moneyness

When trading in options, it’s critical to understand option moneyness, as it differs fundamentally from buying or selling stocks. Unlike stocks that can be bought low and sold high, options are time-bound instruments subject to expiry and value decay. This makes moneyness a vital concept in identifying profitable trades. Misinterpreting it—such as buying an out-of-the-money option simply because it appears cheap—can lead to losses. Similarly, selling an in-the-money option without understanding its intrinsic worth may result in unexpected risks.

Types of Moneyness

Unlike traditional securities, options are not valued simply based on their price. Their worth is influenced by how the strike price relates to the current market price of the underlying asset. This relationship is known as moneyness.

Moneyness is broadly classified into:

• At-the-Money (ATM)
• In-the-Money (ITM)
• Out-of-the-Money (OTM)

An option’s moneyness may change throughout its life, based on market movements.

At-the-Money (ATM) Options

An option is said to be at-the-money when its strike price is equal to or very close to the current market price of the underlying asset. This applies to both call and put options.

ATM options primarily carry time value, with little or no intrinsic value. Due to this, they are sensitive to both volatility and time decay, and are often used by traders expecting significant near-term movement.

In-the-Money (ITM) Options

In-the-money options are those that have intrinsic value if exercised at the moment.

• A call option is ITM if its strike price is lower than the market price.
• A put option is ITM if its strike price is higher than the market price.

Intrinsic Value = Market Price – Strike Price

Intrinsic Value = Strike Price – Market Price

The deeper the option is in the money, the higher its premium, due to the greater intrinsic value. ITM options are less likely to expire worthless, which makes them costlier but relatively safer.

Out-of-the-Money (OTM) Options

OTM options carry no intrinsic value, only time value.

• A call option is OTM if the strike price is above the current market price.
• A put option is OTM if the strike price is below the current market price.

OTM options have lower premiums, making them attractive to some traders. However, unless the underlying makes a substantial move in favor, these options can expire worthless. They are high-risk, high-reward plays.

Which Option Should You Trade?

New traders often lean towards buying calls, especially on platforms like m.Stock, because of the leverage involved. Since only the premium is paid upfront, the capital required is low. But this leverage is a double-edged sword—while it can magnify profits, it can also result in complete premium loss if the market doesn’t move in your favor.

When deciding which option to trade—ITM, ATM, or OTM—one must consider the target price of the stock and the timeframe in which that target is expected to be reached.

Target Price and Time Horizon

If you are bullish and expect a significant price increase, OTM options may offer the best return potential. However, if your expected move is modest or you want a better chance of profitability, ATM or ITM options may be more suitable.

Another key factor is time to expiry. Many traders make the mistake of buying short-term options, only for the stock to move after the expiry. To avoid this, longer-duration options give you more flexibility to:

• Exit at profit when the target is hit
• Adjust your stop-loss if the price does not move as expected

Longer expiries help offset time decay and provide room for price action to play out.

In many real-world scenarios, ATM options offer a balanced risk-reward profile. If your price target is met by expiry, ATM and OTM calls may offer better returns due to lower initial cost. But the risk of expiry with no value is also higher with OTM options.

Conclusion

Having clarity on option moneyness is fundamental to trading success. There is no single “best” option type to trade—it all depends on your price outlook and time horizon.

Additionally, implied volatility plays a crucial role in determining option prices. A helpful rule of thumb:

• Buy options when implied volatility is low
• Sell options when implied volatility is high

This is because options become more expensive in high-IV conditions. Even if the underlying moves favorably, a drop in IV can reduce the option’s premium.

Points to Remember

• Moneyness refers to the relationship between an option's strike price and the underlying asset’s current price.
• Options are categorized as in-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM).
• There is no universal best option to trade—it depends on the expected price move and timeframe.
• Always align the strike price selection with your target price and time to expiry.
• Watch implied volatility: it can impact your return even if the underlying moves as expected.