Difference Between OTM, ITM and ATM Options: You Must Know

OTM, ITM, and ATM are different options types showing the relationship between strike price and current market price of the asset.
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Difference Between OTM, ITM and ATM Options: You Must Know
OPEN ACCOUNT
3 min
14-August-2024

Options trading involves understanding three key terms: At-The-Money (ATM), In-The-Money (ITM), and Out-Of-The-Money (OTM) options. These terms describe how the current price of a stock compares to the strike price of an option. Let us understand them in detail and learn why they matter for traders.

What are ATM, ITM, and OTM?

ATM (At-The-Money), ITM (In-The-Money), and OTM (Out-Of-The-Money) are different terms used in options trading. These terms describe the relationship between:

  • The current price of the underlying asset, and
  • The strike price of the option

Let us take a look at their meanings:

ATM

  • An option is considered an ATM when the current price of the underlying asset is equal to the strike price of the option.
  • This situation usually happens as there's no intrinsic value of the option.

ITM

  • An option is considered an ITM when the current price of the underlying asset is favourable in comparison to the strike price of the option.
  • Now, this favourable situation happens differently under both call options and put options.
    • For a call option, if the underlying asset price is higher than the strike price, it is ITM.
    • For a put option, if the underlying asset price is lower than the strike price, it is ITM.
  • It must be noted that ITM options have intrinsic value because they can be exercised for profit.

OTM

  • An option is considered out-of-the-money when the current price of the underlying asset is unfavourable in comparison to the strike price of the option.
  • Again, this unfavourable situation happens differently for both call options and put options.
    • For a call option, if the price of the underlying asset price is less than the strike price, it is OTM.
    • For a put option, if the price of the underlying asset is higher than the strike price, it is OTM.
  • Out-of-the-money options have no intrinsic value.

Example of ATM, ITM, and OTM

Let us assume the share price of XYZ Ltd. is currently trading at Rs. 500 per share, and you have decided to buy a call option. Now, see how these three situations occur in the options market:

ATM (At-The-Money) option

  • You purchased an ATM call option for XYZ Ltd.
  • The strike price of the option is also Rs. 500.
  • This means the strike price is exactly equal to the current market price of XYZ Ltd.
  • This option is called ATM because there's no difference between the strike price and the current share price.
  • In this scenario, if the stock price at expiration increased above Rs. 500, you could profit by:
    • Exercising the option, or
    • Selling it for a higher price
  • Let’s assume that the stock price rises to Rs. 520.
  • Now, you exercised the option to buy the stock at Rs. 500 and immediately sold it at Rs. 520.
  • By doing so, you made a profit of Rs. 20 per share minus the premium paid for the option.

ITM (In-The-Money) option

  • You purchased an ITM call option for XYZ Ltd.
  • This time, the strike price is Rs. 480, which is lower than the current market price of Rs. 500.
  • This means the option has intrinsic value and you can exercise it immediately for a profit.
  • You did the same and:
    • Bought the stock at the strike price of Rs. 480, and
    • Sold it immediately at the market price of Rs. 500
  • By doing so, you made a profit of Rs. 20 per share minus the premium paid for the option.

OTM (Out-Of-The-Money) option

  • You decide to buy an OTM call option for XYZ Ltd.
  • The strike price is Rs. 520, which is higher than the current market price of Rs. 500.
  • This means the option doesn't have any intrinsic value.
  • It relies solely on the possibility of the stock price rising above the strike price before expiration to become profitable.
  • Initially, an OTM call option with a strike price of Rs. 520 doesn't offer immediate profit because the stock price is below the strike price.
  • However, the option can become profitable, if the stock price rises above Rs. 520 before expiration.
  • For example,
    • Let’s assume that the stock price increases to Rs. 530
    • You sold the option for a higher price than what you paid
    • This way, you captured the increase in the option's value due to the rising stock price.

Why traders analyse ATM, ITM, and OTM

Most traders analyse the relationship between these terms and the strike price to determine the potential profitability of the option. Additionally, this understanding helps in:

  • Assessing the risk associated with the position
  • Determining the profit potential
  • Effectively managing the open positions

Also, it is a common practice to use technical indicators in making price predictions. Learn how to use Williams-R-Indicator today!

How do premiums differ across ATM, ITM, and OTM

All three options trading situations offer traders a different risk and reward for their open positions. See the table below to understand how premiums differ across ATM, ITM, and OTM:

ATM options ITM options OTM options
  • ATM options have lower premiums compared to ITM options.
  • This happens because they have no intrinsic value.
  • However, it must be noted that ATM options are sensitive to changes in:
    • Volatility and
    • Time decay.
  • ITM options are the most expensive out of the three.
  • This happens because they have intrinsic value.
  • Also, they offer more profit potential if the underlying asset moves further in the desired direction.
  • Out-of-the-money options are the cheapest out of the three.
  • This is because
    • They have no intrinsic value and
    • They rely solely on the underlying asset's price movement to become profitable.

 

Conclusion

In options trading, understanding ATM, ITM, and OTM options helps assess risk and profit potential. All three terms differ, with ATM options offering a balanced risk-reward profile, ITM options providing immediate profit potential through intrinsic value, and out-of-the-money options carrying lower upfront costs but relying solely on underlying asset movement for profitability.

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Frequently asked questions

Which is better ITM or ATM or OTM?

The choice between ITM, ATM, or OTM options depends on your strategy and market outlook. ITM options offer immediate value and are less risky, ATM options balance risk and reward, while OTM options have higher return potential but come with increased risk due to their lack of intrinsic value.

Which is more profitable ITM or OTM options?
It depends on market conditions and the stock's price movement. ITM options offer immediate profit potential, while OTM options can provide higher returns if the underlying asset moves in the desired direction before expiration.
What do you mean by ATM ITM and OTM strikes?
ATM (At-The-Money) strikes have a strike price equal to the current market price of the underlying asset. ITM (In-The-Money) strikes have a strike price favourable to the current market price. OTM (Out-Of-The-Money) strikes have a strike price unfavourable to the current market price.
What is ITM, OTM, and ATM?

A call option is in the money (ITM) if the market price exceeds the strike price. A put option is ITM if the market price is below the strike price. Out of the money (OTM) options have no intrinsic value, while at the money (ATM) options have strike prices equal to the market price.

Is OTM better than ITM?

OTM options are typically cheaper than ITM options, making them appealing for traders with limited capital. However, ITM options have intrinsic value and can be exercised immediately, offering potentially more stable returns.

What happens if OTM becomes ITM?

If an OTM option becomes ITM due to favourable market movement, its value increases significantly on a percentage basis. This can yield higher returns compared to initially purchasing an ITM option.

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