Out of the Money – Definition

Cite this article as:"Out of the Money – Definition," in The Business Professor, updated December 2, 2019, last accessed October 20, 2020, https://thebusinessprofessor.com/lesson/out-of-the-money-definition/.

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Out Of The Money (OTM) Definition

Out of the money (OTM) is a term commonly used in options contracts, whether it is a call option or put options. A call option is out of the money if the strike price (preset price) of the underlying asset is higher than the current market price. In a put option, on the other hand, the option is OTM is the market price of the underlying asset is higher than the strike price.

An out of the money options contract possess no intrinsic value, it has only extrinsic value. Traders of out of money options strive to sell the options before expiry so as to minimize the degree of loss they would incur on the options.

Option Basics

In every options contract, a premium is paid, this is the cost paid by a party that enables the other party to assume a position in the contract. The seller of an option receives a premium in exchange for their position in the contract, through this premium, the buyer can exercise the right to trade the underlying security at the strike price before the expiration date.

Traders in options contracts derive value or profit from the underlying asset, either by buying or selling the asset. Options are derivatives and traders take positions depending on how they intend to benefit from the underlying asset.

Out of the Money (OTM) Options

In an option, the difference between the current market price of an underlying asset and its strike price tells use whether an option is out of the money (OTM), at the money (ATM) or in the money (ITM).in a call option, if the market price is lower than the strike price, it is OTM, while OTM occurs in a put option if the current market price is higher than the strike price.

Traders of OTM options do not often exercise them since they are likely not going to benefit from the market price if they exercise the option. In most cases, traders sell options so as to recoup losses from its premium.

Here are some important points you should know about Out of the money (OTM);

  • In an options contract, OTM refers to a state in which the option has only extrinsic value and no intrinsic value. This means that the options derives its value from external factors and has no inherent value.
  • OTM occurs in both call options and put options. In a call option, it occurs when the market price lower than the strike price while in a put option, the current market price is higher than the strike price.
  • Premium is paid in every option contract, it is the cost paid to the seller of the contract for assuming a particular position.
  • An option can also be at the money (ATM) or in the money (ITM).

References for “Out Of The Money (OTM)”

https://www.investopedia.com/terms/o/outofthemoney.asp

https://www.thebalance.com › Investing › Options Investing › Options Strategies

https://investinganswers.com/dictionary/o/out-money-otm

https://www.macroption.com/otm-options/

www.lifestyletrading101.com/out-of-the-money-otm-call-option/

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