A call option is said to be ITM when the underlying stock is trading for
more than the option's strike price. By contrast, a put option is ITM when
the underlying stock is trading for less than the option's strike price.
When the strike price of a call option is less than the current price of the
underlying security, the call holder can exercise the option and effectively
acquire the underlying stock for less than the current market price. On
the other hand, the put holder can exercise the put in order to sell the
underlying stock for more than its current market price. For example, if
XYZ is trading at $53, an April 50 call is considered ITM by $3-while the
April 55 put is considered $2 ITM. Note that the value of an option is at
its greatest when it is ITM.
ATM
An option is said to be ATM when the underlying stock is trading at the
same level as the option strike price. In this case, the investor stands to
neither gain nor lose on the option (that is, over and above the initial
capital outlays). For example, the XYZ April 50 call and put will both be
trading ATM when XYZ is trading at $50. Although technically an
option is ATM only when the underlying stock is trading at exactly the
strike price, whenever the underlying stock is trading close to a strike
price, the common practice is to refer to the options at that strike as
ATM options.
OTM
A call option is said to be OTM when the underlying stock is trading for
less than the option's strike price.A put option, by contrast, is OTM when
the underlying stock is trading for more than the option's strike price. The
value of an option is at its lowest when it is OTM.
Therefore, in the case of a call, if the strike of a call is more than the
current price of the underlying security, then the call is said to be OTM
because the holder has the right to purchase stock at a higher price than
the underlying stock's current price. For example, when XYZ is trading at
$48, the April 50 call is said to be OTM by $2.
Similarly, if the strike price of a put is less than the current price of
the underlying security, the put is said to be OTM. You have the right to
sell the underlying stock for the put option for less than the value at
which the stock is trading in the marketplace. Therefore, ifXYZ is trading
at $48, the April 50 put will be ITM by $2. But ifXYZ increases to $53,
the April 50 put will now be OTM by $3 (and, correspondingly, the April
50 call will be ITM by $3).
For an overview, suppose that XYZ is trading at $50 a share. The various
April calls and puts shown next would be in, at, or out-of-the-money as
follows: Figure 4-1 is an example of option strike prices where the underlying
is trading $50/share. As the underlying price fluctuates the options
will fluctuate from being in, at, and out-of-the-money:
Read More: Option Status Relative to the Underlying Stock
