Financial instruments giving its holder the right to transact in an asset are Options
. The asset which is dealt is called underlying asset' and usually can be any commodity, stocks, bonds etc. However, having an appropriate option purchase strategy is imperative to make most of the transaction.
Option moneyness is a key factor in devising an option purchase strategy. Option moneyness is simply the relationship between the price of the underlying asset and the strike price of the option and it arrives at the intrinsic value of the instrument. Acquainting yourself with the nitty gritty of option moneyness not only helps you to decide on the suitable options for various trading scenarios but also helps you increase profitability of options.
The three states of option moneyness are In-The-Money (ITM), At-The-Money (ATM) and Out-of-The-Money (OTM). Options shift states depending on the price of the underlying asset.
In-The-Money (ITM) It is the state of option moneyness which is defined by the existence of the intrinsic value of the option. Call options are termed to be In-The-Money when the price of the underlying asset is higher than the strike price and Put options are In-The-Money when price of the underlying asset is lower than the strike price.
At-The-Money (ATM) Options are At-The-Money when the price of the underlying asset equals the strike price of the options.
Out-of-The-Money (OTM) This state of option moneyness arises when no intrinsic value exists and the option only has extrinsic value. A call option is Out-of-The-Money when the price of the underlying asset is lower than the strike price and Put options are In-The-Money when price of the underlying asset is higher than the strike price.
Calculating timely option moneyness enables traders determine apt trading approaches as well as investors can consider the moneyness while option purchase.