Out Of The Money Options (OTM Options)

What are Out of The Money Options? What Strike Prices are Out of the money and what is the effect?

Out Of The Money Options (OTM Options) Introduction

You must have heard about how profitable it is to buy or sell out of the money options, have you? But what exactly does "Out of The Money Options" or "OTM Options" mean? Is it a special kind of option or is it a special way of referring to certain kinds of options?

This free options trading tutorial shall explain in detail what "Out of The Money Options" are and how they work.

Out Of The Money Options ( OTM Options ) is one of the three option moneyness states that all option traders has to be familar with before even thinking of actual option trading. The other two option status are : In The Money ( ITM ) options and At The Money ( ATM ) options. Understanding how options are priced makes this topic easier to understand. Trading Out Of The Money Options ( OTM Options ) is the most aggressive option trading method with an extremely high profit and risk potential and is recommended only for veteran or experienced option traders. Learn how to trade out of the money options here.

Definition Of Out Of The Money Options ( OTM Options )

stock options which have no intrinsic value.


Yes, a stock option is considered to be Out Of The Money ( OTM ) if it contains only extrinsic value and no intrinsic value. An Out Of The Money Option ( OTM Option ) will expire worthless upon expiration due to Time Decay.

When Is A Call Option Out Of The Money ( OTM )?

A call option is considered Out Of The Money ( OTM ) when the call option's strike price is higher than the prevailing market price of the underlying stock. It confers you the right to buy the underlying stock at a HIGHER price than the prevailing stock price and hence it has no intrinsic value. Such a call option will gain in value very quickly should the underlying stock rally above it's strike price. As it has completely no intrinsic value and requires the underlying stock to gain in price significantly in order to realise a profit, it is also the cheapest to buy in terms of absolute dollars.

Out of The Money Option with strike price extremely close to the strike price is also known as "Near The Money Option".

Example : If GOOG is trading at $300, it's $400 strike call options are Out Of The Money ( OTM ) as it allows one to buy GOOG at $400 when it is trading at only $300 now.

Here is a table explaining the status of a call option against its underlying stock :

Assume GOOG trading at $300 now.
Call Option Status	Strike Price
ITM	$200
ATM	$300
OTM	$400

What Happens When A Call Option Expires Out Of The Money ( OTM )?

When your Call Options expires Out Of The Money ( OTM ), they becomes worthless thus losing all the money put towards buying it initially. (Unless you want to exercise it in order to buy the stock at a higher price than it actually is... I think not. )

This is also the reason why you can lose all your money in option trading. If you put all your money into buying the "cheap" out of the money options and the underlying stock fails to exceed it's strike price, you will lose all your money at expiration.

When Is A Put Option Out Of The Money ( OTM )?

A put option is considered Out Of The Money ( OTM ) when the put option's strike price is lower than the prevailing market price of the underlying stock. This allows you to sell the undelying stock for lower than the prevailing market price which will not make any sense and therefore contains no intrinsic value.

Example : If GOOG is trading at $300, it's $200 strike put options are Out Of The Money ( OTM ) as it allows one to sell GOOG at $200 when it is trading at $300 now.

Here is a table explaining the status of a put option against its underlying stock :

Assume GOOG trading at $300 now.
Put Option Status	Strike Price
OTM	$200
ATM	$300
ITM	$400

What Happens When A Put Option Expires Out Of The Money ( OTM )?

Similar to what happens when a Call Option expires Out Of The Money ( OTM ), an Out Of The Money put option also expires worthless.

Writing Out Of The Money Put Options can result in a very interesting option trading strategy which is the best of all worlds.

Advantages Of Trading Out Of The Money Options ( OTM Options )

1. This is the most significant reason why most option traders trade Out Of The Money Options ( OTM Options ). It has the highest percentage gain on the same move of the underlying stock than At The Money Options ( ATM Options ) or In The Money Options ( ITM Options ).

Assume GOOG trading at $300 now.
Call Option Status	Strike Price	Price Per Contract	GOOG expired at $300	GOOG expired at $500
OTM	$400	$0.10	$0	$100 / $0.10 = 100,000% Gain
ATM	$300	$7.00	$0	$200 / $7.00 = 2,857% Gain
ITM	$200	$101.00	$100	$300 / $101 = 297% Gain

Many beginner option traders think of In The Money Options ( ITM Options ) as expensive options because the price consists of intrinsic value as well as premium value while Out of the Money options consists of only premium value and are therefore cheaper. That is actually a misconception. The real "cost" of an option is really only the premium value because if the underlying stock does not move, the Out Of The Money Options ( OTM Options ) will still be left worthless upon expiration while the In the Money Options ( ITM Options ) would still be left with its intrinsic value.

2. Cheapest to buy in absolute dollars than At The Money Options ( ATM Options ) or In The Money Options ( ITM Options ).

Assume GOOG trading at $300 now.
Call Option Status	Strike Price	Price Per Contract
OTM	$400	$0.10 x 100 = $10
ATM	$300	$7.00 x 100 = $700
ITM	$200	$101.00 x 100 = $10100

Beginner option traders need to remember that every stock option contract represents 100 shares of the underlying stock and therefore one would pay 100 times the asking price of a single option contract in order to open a position.

Disadvantages Of Out Of The Money Options ( OTM Options )

1. You can lose all your money when the Out Of The Money Options ( OTM Options ) expire worthless.

2. Highest risk of loss than In The Money Options ( OTM Options ) and At The Money Options ( ATM Options ). Because Out Of The Money Options ( OTM Options ) requires the underlying stock to move significantly, exceeding its strike price in order to result in a profit.

Assume GOOG trading at $300 now.
Call Option Status	Strike Price	Amount GOOG Needs To Rise For Profit
OTM	$400	$101
ATM	$300	$7 (premium value)
ITM	$200	$1 (premium value)

The advantages and disadvantages of Out Of The Money Options are condensed and governed by its Options Leverage which can be mathematically measured.

Questions on Out Of The Money Options

:: "Does My OTM Put Profit Before Strike Price Is Reached?"