OTM or Out of the money

DEFINITION of OTM or Out of the money

OTM or Out of the money is one of three terms used in options trading, to describe a call option with a strike price that is higher than the market price of the underlying asset.

WHAT IT IS IN ESSENCE

This is also a put option with a strike price that is lower than the market price of the underlying asset.  

An out of the money option has no interior value, but only possesses time value.

Out of the money is the expression for when an option has not yet reached its strike price. If the option is a call, a bet that the asset will increase in price. Equal to buying or going long.

Being out of the money means that the asset price is still below the strike price.

If it is a put, a bet that an asset will decrease in price, equal to selling or shorting, the option will be out of the money when the asset’s price is above the strike price.

As well as being out of the money, an option can be in the money or at the money. Together, these terms are known as an option’s ‘moneyness’.

HOW TO USE

Out of the money, option premiums reduce quickly as the expiration date gets closer. If the option is still OTM at expiry, the option will expire worthlessly.

OTM options are not the situation for exercising, because the market is offering a trade level more appealing than the option’s strike price. Let’s say, a trader buys a $40 call option and such one has right to buy 100 shares of the stock before the option expires. The stock is currently trading at $29. There is no reason to exercise the option. Because by exercising the option they have to pay $40 for the stock when they can currently buy it at a market price of $29.