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Before we get in to what is ITM, ATM and OTM, it is important to know about intrinsic value. Intrinsic value is the difference between the strike price of the options contract (call option contract or put option contract) and the spot price of the security. After calculating the intrinsic value, we can know the moneyness of an options contract.
The moneyness is classified into three categories namely, In-The-Money (ITM), At-The-Money (ATM) and Out-of-The-Money (OTM). You have to keep in mind that this intrinsic value will change as the spot price fluctuates.
The calculation for intrinsic value differs for call option contract and put option contract. For call option contract, Intrinsic Value is Spot Price minus Strike Price. For put option contract, Intrinsic Value is Strike Price minus Spot Price. The intrinsic value cannot be negative and if the intrinsic value is negative after calculation, then we must consider the intrinsic value as zero for all practical purposes.
Intrinsic Value (Call option contract) = Spot Price – Strike Price
Intrinsic Value (Put option contract) = Strike Price – Spot Price
Besides, we can determine if the strike price is ITM, ATM or OTM by calculating the intrinsic value. If the intrinsic value is positive, then the call or put option contract is ITM. If intrinsic value is zero, then the contract is ATM and if the intrinsic value is negative then the contract is OTM.
Determining the moneyness of a call option and put option
A call option is a contract where the buyer of the contract expects the price of the underlying security to increase in the future. A put option is a contract where the buyer of the contract expects the price of the underlying security to decrease in the future.
Meanwhile, there will be many strike prices and each strike price is decided by the exchange based on the volatility in the underlying script. As the spot price rises or decreases, the intrinsic value will also fluctuate.
Let us assume, a call option contract is denoted as ITC27OCT22C190. The contract denotes that ITC is the underlying scrip, ‘27OCT22’ is the expiry date, ‘C’ denotes call option contract and ‘190’ is the strike price. Instead of ‘C’, if it was ‘P’, then the contract is a put option contract. The contract would look like ITC27OCT22P190.
Similarly, there will be another contract — ITC27OCT22C200. Here, the strike price is ‘200’. In this way, there will be many contracts representing different strike prices for an underlying scrip.
It is totally based on the buyer to buy a put option contract or a call option contract based on his/her expectation of the future price of the underlying scrip.
Now, we will learn about ITM, ATM and OTM with call option contract as an example
If the strike price of the contract is higher than the spot price, then it is OTM. If the strike price of the contract is less than spot price, then it is ITM. If the strike price is close or equal to spot price, then it is ATM.
So, let us see an example. If the spot price of ITC is 200 and the strike price of the contract you bought is 190, then the contract is ITM. If the strike price was 210, then the contract is OTM. If the strike price was closer like 198 or 201 or equal to spot price i.e. 200, then the contract is said to be ATM.
We will see another example. The below table is an example of call option contract and you can see how the same contract with strike price 190 can become ITM, ATM or OTM when the spot price increases or decreases.
Scenario | Strike Price | Spot Price | Intrinsic value | Moneyness |
Scenario 1 | 190 | 200 | 10 | ITM |
Scenario 2 | 190 | 191 | 1 | ATM |
Scenario 3 | 190 | 180 | -10 | OTM |
The working of put option contract is slightly different and the exact opposite of call option contract. Put option contract when the trader expects the price of the underlying scrip to fall. Therefore, if the strike price is higher than the spot price at the time of buying the contract, then the contract is ITM. If the strike price of the put option contract is lower than the spot price, then the contract is OTM. Remember, Intrinsic Value of Put option contract is calculated as Strike Price minus Spot Price.
The below table shows how a put option contract that is ITM can become ATM or OTM as the spot price increase or decreases.
Scenario | Strike Price | Spot Price | Intrinsic value | Moneyness |
Scenario 1 | 100 | 94 | 6 | ITM |
Scenario 2 | 100 | 99 | 1 | ATM |
Scenario 3 | 100 | 110 | -10 | OTM |
Further, as a trader you should know that to buy a contract you have to pay a premium. This premium is the cost of the contract and ITM contracts have higher premium than OTM contracts.
Finally, you will find only monthly contracts when the underlying scrip is a company stock. When the underlying scrip is Nifty 50 index and Bank Nifty index, then you will find weekly and monthly contracts.