What does “out of the money” mean, what are “strike price” and “expiration date”

strike priceIf you read about our strategy, you will come across such terms as “strike price” or “out of the money put option“.

Strike price is the price at which a put or call option can be exercised.

Options have an “expiration date“. Option contract is only valid until the expiration date.   After the expiration date, if a contract is out of the money it becomes worthless or $0.  If a contract is in the money then it will be automatically exercised.

Example

Let’s say that today 10/3/2017 the stock of YNDX is trading at $34.
Because you think the stock price will go down during the month, you may purchase 10 puts of the strike price $26 for $.36 expiring Nov 3, 2017. That means you have the right to sell (sell short) 1000 shares of YNDX stock for a strike price of $26 per share until Nov 3rd.
Let’s say on Nov 1st the earnings report comes out and stock price falls to $20 per share.  You have 2 choices.  You can either exercise your put and sell 1000 shares of the stock short at $26 or you can just sell your put for $6.
In other words you’ve risked $360 for potentially big return, in our example it’s $6000 – $360 = $5,640!

Moneyness

Out of the money” or “OTM” term means that a put option has a strike price lower than the market price of the underlying stock. In the above example, 26th put is “out of the money” because it is priced lower than current $34 stock price. In fact, any put with strike price below $34 is “out of the money”. By the same token, any put with strike price above $34 is “in the money”. And when the strike price is equal to the market price of underlying security, it is said to be “at the money”.

Here is a simple table to illustrate “in”, “out”, and “at the money” terms for put and call options:
OTN ITM ATM

Generally “out of the money” options are significantly cheaper than “in the money” or “at the money” options.

It is said that “out of the money” option has no intrinsic value, but only possesses extrinsic or time value.

Read on how you can turn the put-buying strategy around and make money by selling puts.

IgrenaFinancial

Over 20 years in the stock market

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