Out of the money (OTM) – out of money

Out of the money (OTM) or out of money is the name of a financial option that has no intrinsic value. This would be the case for a call option for which the spot price of the underlying asset is lower than the option’s exercise price. In turn, we will say that a put option is out of the currency or out of the money when it is not exercisable.

Out of the money (OTM) - out of money

In the case of a call OTM option:

Strike Price> Underlying Price

The call is not exercisable since it is cheaper to buy the asset in the cash market.

call OTM result

In the case of the put OTM option:

Strike price < Underlying price

put OTM result

The other possibilities are that:

  • The option is at money (ATM): The strike price is equal to the underlying price.
  • The option is in money (ITM): The option has intrinsic value.

Example of an out-of-money option

Let’s look at some examples of out-of-money options:

  1. Call option on BBVA

As of 07/16/10, the BBVA share price is € 8.67. An investor thinks that the title could rise during the last quarter of 2010. However, the uncertainty is very great and he decides not to risk buying the shares in cash.

Consequently, it decides to buy 100 contracts of a call option on the bank BBVA with expiration on 12/17/10 and a strike price of € 10.50. You pay a premium of 0.70 basis points for each contract. We will assume that you hold your position in options until the expiration date of the contract.

As in futures contracts, the nominal value of each option contract is 100 shares. Therefore, the buyer pays the seller an amount in premiums of € 7,000 (100 x 0.70 x 100) for the right to buy 10,000 BBVA shares (100 contracts x nominal of 100 securities) at € 10.50, up to the due date.

The risk of the buyer of the call options is limited to € 7,000.
The risk of the seller of the call options is unlimited.

To determine the break-even of the operation or level from which the buyer of the option contracts makes a profit, we have to add the premium paid to the exercise price of the option:

BE = € 10.50 + € 0.70 = € 11.20

From € 11.20 per 1 BBVA share, the buyer wins.

  • OTM case: The BBVA share is trading below € 10.50. The call option is not exercisable. The buyer loses the 7,000 euros that he has paid for the premiums and the seller gains € 7,000.

2. Put option on the Yahoo stock

As of 07/16/10, Yahoo’s stock is trading $ 14.90. An investor thinks that it is overvalued and therefore should go down in the next few months. However, it does not want to position itself short selling securities in short, for fear of new measures of expansionary monetary policy that could cause a bullish section of the stock indices. Therefore, you decide to buy 100 put option contracts with expiration 10/15/10 and a strike price of $ 13. You pay a premium of 0.29 basis points for each contract.

As in futures contracts, the face of each option contract is 100 titles. The buyer of the put options pays the seller a premium of $ 2,900 (100 x 0.29 x 100), for the right to sell him 10,000 Yahoo titles (100 contracts x 100 nominal) at a price of $ 13 , until 10/15/10. We will assume that the option position is held until the option expires.

The buyer’s risk of put options is limited to $ 2,900.
The seller’s risk in the event of a drop in the share price is unlimited.

To determine the break-even of the operation or level from which the buyer of the put makes a profit, we have to subtract the premium paid from the strike price:

BE = $ 13 – $ 0.29 = $ 12.71

When the Yahoo stock falls below $ 12.71, the buyer of the put options profits.

  • OTM Assumption: Yahoo’s price is higher than $ 13.

The option is not exercisable. The buyer loses $ 2,900 corresponding to the amount of the premiums he has paid. The seller of the options makes $ 2,900.