IN-THE-MONEY, AT-THE-MONEY, OUT-OF-THE-MONEY: EXPLAINED

Options trading involves a set of essential terminologies that dictate potential risk and rewards for traders. Among the most crucial concepts are the ideas of In-the-Money (ITM), At-the-Money (ATM), and Out-of-the-Money (OTM). These terms describe the relationship between an option's strike price and the current price of the underlying asset.

Understanding these components of "moneyness" is foundational to executing successful options strategies. Whether you're considering Covered Calls, Spreads, or just speculating, knowing whether an option is ITM, ATM, or OTM provides vital context for selecting the right tool for the trade.

This article will cover:

• Clear definitions of ITM, ATM, and OTM for calls and puts
• Real-world examples of how each option type behaves
• Practical trade-offs and uses in common trading strategies

Defining “Moneyness” in Options

“Moneyness” refers to the intrinsic value of an option. It establishes whether exercising the option today would produce a financial benefit. Here’s how each type breaks down:

In-the-Money (ITM)

• Call Option: The option is ITM when the underlying price is above the strike price.
• Put Option: ITM when the underlying price is below the strike price.

These options have intrinsic value. For example, if a call option has a strike price of £50 and the stock is trading at £60, it’s £10 in-the-money.

At-the-Money (ATM)

• Applies to both calls and puts when the underlying price equals or is very near the strike price.

ATM options are purely speculative, as they hold no intrinsic value, only time value. They’re frequently used in high-frequency and short-term strategies like straddles or strangles.

Out-of-the-Money (OTM)

• Call Option: OTM when the strike price is above the stock price.
• Put Option: OTM when the strike price is below the stock price.

These have zero intrinsic value. For example, a £50 call when the stock trades at £45 is OTM by £5. Their value is composed entirely of time and volatility components, making them cheap to purchase but risky.

Beyond simply understanding the definitions, moneyness plays a pivotal role in how an option is priced, which in turn affects a trade’s profitability and risk. Options are affected by several pricing components, such as time to expiry, volatility, and interest rates, but none more immediately than whether it’s ITM, ATM or OTM.

Time Value and Intrinsic Value

The price of an option (its premium) can be broken into two components:

• Intrinsic Value: How far ITM the option is
• Time Value: What the market is willing to pay for the chance it will be ITM at expiry

ITM options always carry intrinsic value. ATM and OTM options do not, and are priced solely on the expectation they might gain value before expiry.

Volatility Sensitivity

OTM and ATM options are more sensitive to volatility than ITM ones. Higher implied volatility increases premiums for OTM options more dramatically since there’s a greater chance the option could become profitable. This makes them popular tools during earnings season or when anticipating market catalysts.

The Greeks & Moneyness

Let’s look at how each moneyness level responds to the option Greeks:

• Delta: ITM options have a high delta, indicating significant price sensitivity. OTM options have a low delta, meaning their price moves less with the underlying.
• Gamma: Highest with ATM options, indicating rapid delta changes with small price moves.
• Theta: ATM options decay faster; they lose value daily as expiration nears.

Traders use the Greeks to optimise strategies around risk tolerance, directional bets, and time horizons, with moneyness as the foundational filter.

Liquidity and Bid/Ask Spreads

ATM options are generally most liquid, leading to tighter bid/ask spreads. This makes entry and exit cheaper and easier. ITM and OTM options can have wider spreads, particularly in less active stocks or further-dated expiries.

Premium Costs and Capital Requirements

ITM options are more expensive due to their intrinsic value. For a call buyer, acquiring deeply ITM options can tie up more capital but offer more stability and delta exposure. OTM options are inexpensive, making them alluring for speculative plays or larger volume positioning.

Example: If ABC shares trade at £100:

• Call £90 (ITM): Costs £13, approximating the £10 intrinsic + £3 time value
• Call £100 (ATM): Costs £5, mostly time value
• Call £110 (OTM): Costs £2, purely time value

This influences trader decision-making when balancing cost versus potential reward.

Once traders comprehend moneyness categories and their pricing implications, applying these elements effectively becomes a strategic decision. From aggressive speculation to conservative income generation, each type of option fits a unique use case, with trade-offs in terms of risk, reward, cost and probability.

Profit Probability vs. Potential Return

There is a crucial trade-off to understand:

• ITM options: Higher likelihood of finishing in profit but with lower reward multiples.
• OTM options: Lower chance of expiring profitable, but with higher return potential due to low initial cost.

ATM options occupy middle ground, offering flexible strategies responsive to volatility spikes or directional plays.

Options Strategies and Moneyness

Different option strategies are built around these moneyness distinctions:

• Covered Calls: Often written OTM or ATM. This allows upside before shares are called away.
• LEAPS or longer-term investing: Conducted ITM to mirror stock behaviour with less capital.
• Vertical Spreads: Use both ITM and OTM legs to define risk/reward in a defined-trade logic.
• Straddles/Strangles: Use ATM or slightly OTM options for volatility-based trades.

Capital Efficiency and Risk Management

Choosing option moneyness affects required margin and potential loss. OTM positions may seem "cheap," but they often expire worthless, creating a long-term cost drain. Conversely, ITM options protect better against time decay but tie up more funds.

Traders focused on risk-adjusted returns often prefer ITM setups, particularly in longer-term strategies. Those prioritising asymmetrical upside typically lean on OTM positions, accepting their lower win probability.

Tax and Assignment Considerations

ITM options close to expiry are more susceptible to early exercise and assignment risk. This matters in income strategies (like covered calls) where tax and dividend timing play a relevant role.

Understanding the full picture behind exercising, moneyness, and expiration helps prevent surprise assignments and allows for more precise exit planning.

Educational and Tactical Importance

Options traders who understand ITM, ATM, and OTM not only grasp pricing mechanics but are better equipped to:

• Tailor strategies to match conviction and volatility outlook
• Control risk while maintaining upside potential
• React to live market conditions with informed judgement

Ultimately, moneyness serves as the language of options positioning. By mastering this vocabulary, traders unlock the ability to build complex, highly-adjusted strategies or simply enhance day-to-day speculation.