OpenMarkets Weekly: In And Out Of The Money Options

In the last episode, we reviewed the Greeks and what they mean for options pricing.

Continuing our look at options and their unique terminology, it's also important to understand how the strike price in options determines how the option moves and is labeled in the market.

Any option will be in one of three positions: In the money, at the money or out of the money.  This is a reference to where the option is in relation to the underlying asset it reflects.

Out of the Money

"Out of the money" options are those with strike prices that are significantly above or below the price of the underlying asset.  These options trade with a low delta and are all premium with no intrinsic value. They are used to mitigate risk for large moves and are easy to understand. An example would be if the S&P 500 futures were trading at 3300, a 3400 call or a 3200 put, trading at 50 points, would be all premium with no intrinsic value.

At the Money

As the underlying asset nears the "Out of the money" strike, it takes on the characteristic of an "At the money" option. At this point in the lifecycle of the option we can witness both delta and gamma starting to change.

Remember delta is the rate of change on the option premium, and gamma is the rate of change on the delta.

These "At the money" options have higher deltas and are usually the strikes with the highest volume and open interest. An example would be either a 3300 call or 3300 put with the S&P 500 futures trading 3300.

In the Money

"In the money" options have intrinsic value.  For example, if the S&P 500 futures are trading at 3300, an S&P 500 Micro E-mini 3200 call would have 100 points of intrinsic value.  If the option premium is trading at 150 points, then it would equate to 100 points of intrinsic value and 50 points of pure premium. The further an option becomes "in the money" the more it trades one to one with the underlying asset.

It's important to understand the significance of time decay when trading options. All premium decays to zero at expiration leaving nothing but intrinsic value.  Understanding the relationship between premium levels and the various strikes gives active traders the tools to start developing an effective options trading strategy.

More on Options:

Know Your Options Language  

Options Education for Active Traders

The post OpenMarkets Weekly: In and Out of the Money Options appeared first on OpenMarkets.

To learn more about futures and options, go to Benzinga's futures and options education resource.