ITM, ATM, OTM

Before we continue, it is important to understand the difference between In-the-Money (ITM), At-the-Money (ATM), and Out-of-the-Money (OTM) options.

Moneyness is a term used to describe the relative position of an underlying asset's current price (or future price), such as a stock, in relation to the strike price of a derivative. The terms ITM, OTM, and ATM are used to describe the intrinsic value of an option. Intrinsic value refers to the amount by which an option is in-the-money (ITM). Options that are ITM have positive intrinsic value, while options that are 'out-of the-money' (OTM) or 'at-the-money (ATM) have an intrinsic value of zero.

However, an option may still have time value (also called extrinsic value) even if it's out-of-the-money or "at-the-money." Time value is based on the potential for the option to become "in-the-money" before expiration. The closer the strike price is to the current market price, the greater the time value. Time-value increases when the time to expiration is longer or the option is near-the-money (NTM).

In-The-Money (ITM)

An option is 'in-the-money' when it holds positive intrinsic value or when it would be profitable to exercise the option right away. If exercised, the option buyer can achieve immediate profit due to the favorable difference between the strike and market prices.

• A call option (the right to buy) is "in-the-money" when the strike price is lower than the current market price of the underlying asset. Therefore, you could exercise the option, buy the asset at the strike price, and selling it again at the higher market price for a profit.

• A put option (the right to sell) is "in-the-money" when the strike price is higher than the current market price of the underlying asset, meaning you could exercise the option, sell the asset at the strike price, and buy it back at the lower market price for a profit.

At-The-Money (ATM)

An option is considered 'at-the-money' when it does not have any intrinsic value, as the strike price is equivalent to the current market price of the underlying asset. In this situation, the option holder doesn't gain or lose money if the option is exercised immediately.

• A call option is "at-the-money" when the strike price is equal to the current market price of the underlying asset. The option holder can buy the asset at the same price it is currently trading in the market, yielding no immediate profit.

• A put option is "at-the-money" when the strike price is equal to the current market price of the underlying asset. In this case, the option holder can sell the asset at the same price it is currently trading in the market, again yielding no immediate profit.

Out-Of-The-Money (OTM)

An option is 'out-of-the-money' when it does not hold any intrinsic value. This situation occurs when the strike price of the option is not in a favorable position compared to the current market price of the asset. OTM options are typically sold when possible. If left unexercised till expiration, they become worthless and the option seller (or writer) keeps the premium received at the time of selling the option.

• A call option is "out-of-the-money" when the strike price is higher than the current market price of the underlying asset. This is because the option holder would need to buy the asset at a price higher than the market price, which is not profitable.

• A put option is "out-of-the-money" when the strike price is lower than the current market price of the underlying asset. The holder of the option would be in a position where they need to sell the asset at a price lower than the market price, which is not advantageous.