Itm Otm And Atm Options
29 January, 2024
What is Options?
Options are financial instruments or contracts that provide the buyer with the right, but not an obligation, to indulge in a transaction at a predetermined price before the maturity date of the contract. The amount you pay to acquire this right is known as the option premium, which is impacted by various factors.
Since options are derivatives, i.e. they derive their value from an underlying asset. The price of the underlying asset is the most significant factor influencing the premium of the options. Options are traded widely on exchanges and OTC markets. They are used for hedging and speculation purposes.
Types of options contracts
Call option: A call option provides the buyer of the contract a right to purchase the underlying asset from the seller at the predetermined price before the expiry / maturity date of the contract. The seller of the options contract will be obligated to transact if the buyer decides to exercise their right.
Put option: A put option provides the buyer of the contract a right to sell the underlying asset to the buyer at the predetermined price before the expiry / maturity date of the contract. The seller of the options contract will be obligated to transact if the buyer decides to exercise their right.
Options - ITM, ATM and OTM
You might have already heard of terms like in the money, out of the money or at the money options. But what exactly do these terms mean and how do they impact the prices of an options contract?
In the money option
An options contract is referred to as in the money only when the underlying asset's price is favourable to the strike price options contract. The price difference between the underlying asset and the strike price is the intrinsic value of the options contract. A call option is considered as in the money option when the strike price of the options contract is less than the underlying asset's price.
For example, consider Nifty 50 is trading at a price of ₹19,500, and you are holding a call options contract for a strike price of ₹19,400. It is set to expire at the end of this month. At the current price level, your options contract is ITM, and the intrinsic value of your call option would be ₹100. The vice-versa is true for a put option contract, i.e. the strike price should be higher than the price of the underlying asset.
At the money option
An options contract is an ATM contract when the market price of the underlying asset is almost equal to or near the strike price of the options contract.
An interesting thing to note here is that the ATM strike price will be the same for the call option and put option for a given point in time. In this case, the criterion isn't whether the price is advantageous or not, but rather its proximity to the strike price matters.
For example, if the Nifty 50 is trading at a price of ₹19,500, then both the call and put options contract with the strike price of ₹19,500 will be deemed as an ATM option contract.
Out of the money option
Here, the logic is exactly opposite to that of an ITM options contract. An option is referred to as OTM only when the strike price of the options contract is unfavourable to the underlying asset's price. In such a scenario, an options contract will not have any intrinsic value. All the premiums will be driven by time value and volatility.
For example, if the Nifty 50 is trading at a price of ₹19,500, then a call option with a strike price of ₹19,600 (or any other price above ₹19,500) will be considered an OTM option.
The vice-versa is true in the case of a put options contract.
For example, if the strike price of the put contract in this example is ₹19,400 (or below), the contract will be deemed an OTM option.
In OTM, the market usually refers to the strike prices as slight OTM and far OTM, depending upon the gap in the underlying asset's price and the strike price of the option contract.
Other factors influencing the price
Apart from the underlying price of the asset, there are a few major factors that have an impact on the option pricing -
Time value: The remaining time until an options contract expires has a significant impact on the option's price. The time remaining contributes to the option's price beyond any intrinsic value it may have. In the case of an OTM option, the entire premium is a factor of the time value, as there is no intrinsic value for such options contracts.
Volatility: The higher the volatility in the underlying asset's price, the higher would be the option premium. Similarly, with increased volatility, the chances of options contracts getting ITM or a higher intrinsic value increase.
Interest rates: The risk-free interest rate is used in the markets and valuation to discount the future cash flows associated with any investment. Interest rates are typically stable, but can still impact the price of an options contract as and when the risk-free interest rate gets changed.
Conclusion
We hope this article helped you learn more about what is in the money call option, how options are priced in the market and some technical terms around option contracts. If you plan to excel in your trading journey, you can choose the HDFC Bank Demat Account. It allows you to easily transact in equities and derivatives, to name a few.
Nonetheless, it is essential to remember that like any other financial security, options are also subject to market risk and are often categorised as highly volatile securities.
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*Terms and conditions apply. This is an information communication from HDFC Bank and should not be considered as a suggestion for investment. Investments in securities market are subject to market risks, read all the related documents carefully before investing.
