An option can be described as being in one of three states: In-the-money (ITM), at-the-money (ATM) or out-of-the-money (OTM).
• An option is in-the-money (ITM) when the strike rate is better than the underlying market rate.
• An option is at-the-money (ATM) when the strike rate equals the underlying market rate.
• An option is out-of-the-money (OTM) when the strike rate is worse than the underlying market rate.
These states are known as an option’s ‘moneyness’. Unless the strike equals the market rate, the ‘moneyness’ of a Put option differs from that of a Call option:
When the strike rate of a long (buy) Put is above the market rate, we say it is in-the-money because the strike allows you to sell at a higher price. When the strike rate of a long (buy) Call is below the market rate, we say it is in-the-money because the strike allows you to buy at a cheaper price.
When an option is in-the-money (ITM), it is more valuable, i.e. its premium is higher. Hence, ITM options are the most expensive to buy, whereas out-of-the-money (OTM) options are the cheapest. Paying more for an option means you are risking more, however an ITM option has a higher probability of returning a profit. Buying an OTM option is a smaller risk, but the probability of profit is lower. In each trade, you enter a strike rate depending on your market outlook and risk appetite.
Use the platform to select either a Call or Put option and experiment by entering different strike rates. You will see, as you adjust the strike, the premium-to-pay changes.
Buying an at-the-money Put option
If you buy a Put with a strike equal to the market rate, we say it is at-the-money (ATM). If the market falls, the strike will become in-the-money (ITM) since the sell price of the strike is higher than the market. But, if the market rises, the strike will be out-the-money (OTM). The diagram below demonstrates this concept.
Buying an at-the-money Call option
When you buy a Call option with a strike equal to the market rate, it is ATM. If the market rises, the strike will become ITM since the buy price of the strike is cheaper than the market. But if the market falls, the strike will become OTM. The diagram below demonstrates this concept.
Examples of buying Long Call options – ATM, OTM, ITM
The following three images depict EUR/USD buy call options ATM, OTM, and ITM.
In the ATM buy call option image above, the underlying EUR/USD rate was trading at 1.12252 and valued at 345.47 USD.
Setting an option with a strike of 0% means the strike rate equals the market rate at open.
In the OTM buy call option above, a strike price +2% above market has been selected. This means the trader is reserving a worse rate than what is currently available in the market and the following happens – the value of the option decreases to 54.50 USD.
In the ITM buy call option above, a strike price -2% below market has been selected. This means the trader is reserving a better rate than the market and the following happens – the value of the option increases to 1,190.11 USD.