An option is out-of-the-money (OTM) when it leads to a negative result in case of immediate execution of an option. OTM means the spot price of underlying shares is lower than the strike price when it comes to call options and higher for puts.
For the identification of options, the purpose of which lies in the comparison of the option exercise and the underlying asset prices, we can emphasize 3 main groups:
- in-the-money (ITM)
- out-of-the-money (OTM)
- at-the-money (ATM)
Talking about calls, «out-of-the-money» can be determined when: Asset price < Call strike price
Talking about puts, «out-of-the-money» can be determined when: Asset price > Put strike price
For the amount the option is ITM the term «intrinsic value» can be applied.
If an option is OTM at expiration, in other words it’s intrinsic value equals zero, the contract is considered worthless.
Let’s take the following example: the call option has the strike price of $90 and the current asset price is $75. It indicates the option is OTM, that is it’s at a loss at the moment, and an investor will suffer losses provided the option is directly exercised.
There are also terms that specify the degree or depth. For instance, an option with a large profit is usually called deep in-the-money. Accordingly, options with a large loss are called deep out-of-the-money. This concludes that the option contract under consideration has more distant exercise price than the current price of our asset in comparison with another contract.
Suppose, the strike price of the call is $90 and if the price of the asset is $75 and we say this contract is OTM, then another call with the strike of $105 provided the maintenance of the same asset price can be called deep OTM. At the same time the option with the same strike and lower stock price (let’s say, $60) will be also deep OTM, will have no intrinsic value since this option in such situation can make greater loss than the first one