In-the-money, at-the-money, and out-of-the-money are commonly used terms that refer to an option's moneyness, an insight inꩵto the intr⛎insic value of these derivatives contracts.

This article covers the basic concepts of moneyness, which also bears on 澳洲幸运5官方开奖结果体彩网:option valuation and trading.

Overview: Elements of Option Pricing

As a basic overview, let us consider a typical option quote that will contain the following information:

• Name of the 澳洲幸运5官方开奖结果体彩网:underlying asset - i.e. ABC Corp. stock
• Expiration date - i.e. December 2020
• Strike price - i.e. 400.00
• Class - i.e. Call vs. Put
• Price - i.e. The option premium

The price of an options contract is known as the 澳洲幸运5官方开奖结果体彩网:option premium, which is the amount of money that the buyer of an option pays to the seller for the right, but not the obligation, to exercise the option. This should not be confused with the 澳洲幸运5官方开奖结果体彩网:strike price, which is the price at which a specific option contract can be 澳洲幸运5官方开奖结果体彩网:exercised.

These elements work together to help you determine the of an option - a descr▨iption of the option's intrinsic value, which is related to its strike pri🌼ce as well as the price of the underlying asset.

Intrinsic Value and Time Value

The option premium can be theoretically broken down into two components:

• 澳洲幸运5官方开奖结果体彩网:Intrinsic value and
• Speculative or 澳洲幸运5官方开奖结果体彩网:time value (also known as 澳洲幸运5官方开奖结果体彩网:extrinsic value).

The intrinsic value involves a straightforward calculation - simply subtract the 澳洲幸运5官方开奖结果体彩网:market price from the strike price - representing the profit the holder of the option would book&nb☂sp;if they exercised the option, took delivery of the underlying asset, and sold it in the current marketplace.

The time value is then calculat⛄ed by subtracting the intrinsꦡic value of the option from the option premium.

In-the-Money Options

Let's see how moneyness plays out. For example, let's say it's September and Pat is long (i.e. she owns) a December 400 call option for ABC Corp. The option has a current premium of 28 and ABC is currently trading at 420. The intrinsic value of the option would be 20 (market price of 420 - strike price of 400 = 20). Therefore, the option premium of 28 is comprised of $20 of intrinsic value and $8 of time val෴ue (option premium of 28 - intrinsic value of 20 = 8).

Pat's option is "in-the-money". An 澳洲幸运5官方开奖结果体彩网:in-the-money (ITM) option is an option that has some intrinsic value. With regard to a 澳洲幸运5官方开奖结果体彩网:call option, it is an option with a strike price below the current market price. It would make the most financial sense for Pat to sell her call option, as she would receive $8 more per share than by taking delivery and selling the shares in the 澳洲幸运5官方开奖结果体彩网:open market. For a put option, which gives the holder the right to sell shares at a set price, intrinsic value would exist if the strike price is higher than the market price, allowing you to sell the shares for more than they are worth and buy them back lower.

Out-of-the-Money Options

Returning to our example, if Pat was instead long a December 400 ABC put option with a current premium of 5, and if ABC had a current market price of 420, she would not have any intrinsic value (the entire premium would be considered time value), and the option would be 澳洲幸运5官方开奖结果体彩网:out of the money (OTM). An out-of-the-money p💦ut option is an option with a strike price that is lower 😼than the current market price.

The intrinsic value of a put option is determined by subtracting the 澳洲幸运5官方开奖结果体彩网:market value from the strike price (strike price of 400 - market value of 420 = -20). Intuitively, it looks as if the intrinsic value is negative, but in this scenario, the intrinsic value can never be lower than zero.

At-the-Money Options

A third scenario would be if the current market price of ABC was 400. In that case, both the call and put options would be 澳洲幸运5官方开奖结果体彩网:at the money (ATM), and the intrinsic value of both would here be zero, as an immediate exercise of either option would not result in any profit. However, that doesn't mean that the options have no value because they will still have time value.

The Importance of Time Value

Time value is the main reason there is little exercising of options in practice but a considerable amount of 澳洲幸运5官方开奖结果体彩网:closing out, 澳洲幸运5官方开奖结果体彩网:offsetting, covering, and selling of shares or contracts. In our example, Pat would have increased her profit by 40% ($8/$20) by selling her call option instead of taking delivery of the stock and selling the shares. The $8 covers the 澳洲幸运5官方开奖结果体彩网:speculation that exists in regard to the price of ABC between September and its eꦦxpiration in December.

The market determines this part of the premium but it is not a random assessment. Many factors come into play in the establishment of the time value of an option. For example, the 澳洲幸运5官方开奖结果体彩网:Black-Scholes option pricing model relies on the interplay of five separate factors:

1. Price of the underlying asset
2. Strike price of the option
3. Standard deviation of the underlying asset
4. Time to expiration
5. Risk-free rate

The Bottom Line

Understanding the 澳洲幸运5官方开奖结果体彩网:basics of valuing options is part science and part art. It is vital to understa🌃nd where profits come from and what they represent in order to maximize option trading returns. Anyone struggling to determine an option's moneyness may find it useful to work with some of the best online brokers for options trading.

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