In the Money, Out of the Money and At the Money Options

In the Money, Out of the Money and At the Money Options:

A call option is said to be in the money , if the spot price of the stock or index is greater than the strike price.  i.e., you can make money if you exercise or square off the option in the current scenario. The call option is said to be out of the money if the spot price of the stock or index is lesser than its strike price. i.e you cannot make money if you exercise or square off the option at the current situation. The call option is said to be at the money, if the spot price and the strike price of the stock or index is the same.

The above scenario is exactly the opposite in Put option where it is said to be in the money if the spot price is lesser than the strike price, out of the money if the spot price is greater than the strike price and at the money if the spot price and strike price of the stock or index is the same.

Options Pricing:

We already know that to purchase an option we need to pay a premium which is only a small amount of the actual lot value we purchase. Let’s see how this premium price is derived. All options pricing are the sum of the Intrinsic value and the time value of that option though other factors are involved as well but they do not contribute significant change as that of intrinsic value and time value.

I.e., Options price = Intrinsic Value of that option + Time Value of that option

For eg, if the time value is 10 and the intrinsic value is 20, then the option price is 30. But it will not be exactly 30 as other minor factors like volatility, interest rates and dividends also contribute to the option pricing.

Intrinsic Value:

Intrinsic value is the difference between the spot price and the strike price of the option and is considered either positive or zero but never be negative as there is no point in buying the option if it is out of the money. So the option has intrinsic value only if it is in the money and the intrinsic value of the at the money option and out of the money option is always zero. For example if the spot price of the call option is 350 while the strike price is 340, then the intrinsic value of the call option is 350-340 = 10. Like wise, if the strike price is 340 and the spot price is 330, the intrinsic value is 0 and not -10 as it can never be negative.

Time Value:

Time value of the contract depends on the time interval between the current date and the expiry date. The longer the time interval, the larger the time value and vice versa. This is because, the possibility of the stock or index to move a large distance and hence make the large profit to the position holder is large when the time gap is more compared to the situation when time gap is lesser. This is why the options are priced very high during the initiation of contracts compared to the dates nearer to the date of expiry.