ATM, OTM, ITM: 10 Key Differences To Know Before Choosing

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Written by Arjun Remesh | Reviewed by Shivam Gaba | Updated on 6 December 2024

Understanding the differences between At The Money (ATM), Out Of The Money (OTM), and In The Money (ITM) concepts is crucial to anyone involved in Options Trading. ATM, OTM, and ITM describe the moneyness of the options that influence suitability and value for an option trading. The differences between ATM, ITM and OTM help us understand the relationship between the option’s strike price and the underlying asset’s current market price. In turn, the classification plays a significant role in determining the option’s value and potential profitability.

Moneyness refers to how the option’s strike price compares to the asset’s market price. The classification is essential for the traders to evaluate their positions and make informed decisions. In the case of ATM, the strike price is approximately equal to the market price. It doesn’t indicate the intrinsic value, which means they do not offer immediate profit. However, they have time value, which is potential future gains. Conversely, OTM options occur when the strike price is less favourable than the market price, which results in no intrinsic value.

The traders can choose it if they believe the market will move favourably before the options expire. ITM options, on the other hand, occur when the strike price is quite favourable to the market price, giving better intrinsic value. This means that they could be exercised for profit at that time. To understand it better, let’s delve into the key differences to make the right choice and achieve financial goals.

1. Strike Price vs. Market Price

The strike price is a predetermined price at which the options contract holder can buy (for a call option) or sell (in the case of a put option) the underlying asset. The price is established when the options contract is created and remains fixed throughout the option’s life. The strike price is crucial as it helps determine the option’s intrinsic value. It is a benchmark for assessing whether an option is ITM, ATM or OTM. 

In contrast to the strike price, the market price is the underlying asset’s current trading price in the open market. The price is dynamic, fluctuating as per the demand and supply, varied market factors and investor sentiment.

An option is an ATM when the strike price is approximately equal to the current market price of an underlying asset. For example, if the stock is trading at ₹150 and the option’s strike price is ₹150, it is an ATM. Exercising the option in this scenario indicates no profit or loss. This is because the delta here is typically around 0.5, indicating balanced sensitivity to price movements.

An OTM option is a situation where the strike price remains less favourable than the current market price. For example, if the call option has a strike price of ₹160 and the underlying assets are traded at ₹170, it is the case of OTM. Herein, the options have a lower delta, reflecting the speculative nature, without immediate tangible value. So, exercising this option isn’t beneficial.

Conversely, an ITM option is a case that indicates a favourable strike price in comparison to the underlying asset’s market price. For instance, if the call option has the strike price set at ₹140 and the stock trades at ₹150, it is an ITM. ITM options generally have a high delta. It indicates greater sensitivity to the market movement and high profitability likelihood. To exercise the option here, therefore, will yield profit.

2. Intrinsic Value

The intrinsic value of an option is the tangible and real value that comes from options if it is to be exercised immediately. It is the difference between the underlying asset’s current price and option’s strike price, but only if the difference remains favourable to the option holder. For the call option, it is calculated as the current Market Price of the underlying asset – strike price), provided the result offered is positive.

If the calculation offers a negative number or zero, the intrinsic value is considered zero, as options cannot be exercised for loss.

Intrinsic value is an essential component in determining the option’s overall premium, alongside the extrinsic value, which includes factors like volatility and time value. Understanding intrinsic value allows traders to access options’ immediate value and make informed decisions regarding trading strategies.

Let’s say a share is currently traded at ₹2,500. Then,

• ITM call option- With strike price of ₹2,400, the intrinsic value will be (₹2,500 – ₹2,400) = ₹100
• OTM call option- With strike price of ₹2,600, the intrinsic value will be (₹2,500 – ₹2,600) = ₹0, as the derived value is negative.
• ATM call option- With strike price of ₹2,500, the intrinsic value will be (₹2,500 – ₹2,500) = 0.

By understanding these relationships can help traders evaluate the options in an effective manner.

3. Premium (Cost of Option)

Option premium is the cost paid to purchase an option, encompassing extrinsic and intrinsic value. The relationship between market price and strike price influences option premium. When the option is ATM, it indicates a strike price closer to the underlying asset’s current market price. ATM options, in general, have moderate premiums. They balance intrinsic value and the potential for future changes within market conditions.

OTM options have strike prices which are less favourable than market prices. It means that for the call options, the strike price remains above the market price. On the other hand, the strike price is below the market price for the put option. The options do not offer immediate profit potential, so they have a lower premium. The value of OTM options hinges on the possibility of future market movements in the favour of investors. It makes it more speculative.

In contrast, ITM options have a strike price that is favourable in comparison to the market price. This means they have some intrinsic value already. This results in ITM options tending to higher premiums. It reflects their high potential for immediate profit, as they can be exercised for the gain then and there.

4. Profitability Potential

Profitability potential depends on the moneyness and the market conditions in the case of ATM, OTM, ITM. The ITM option offers higher profitability because of the higher delta and potential for immediate gain. Delta here is a risk metric which, estimating the price changes of options, helps understand how it will move for every change within the underlying security’s price. It increases investors’ confidence in the option, making it a preferred choice for those seeking reliable returns. 

The OTM option, on the other hand, yields some significant returns with the favourable movement of the underlying assets. However, OTM options carry high risk. 

The return potential of an ATM option is much more balanced. Understanding this potential helps traders assess the ratio of risk to reward. It allows them to make informed decisions and gain better stability amidst market volatility.

For varied options, the delta value varies. It reflects expected gain based on the point movements within an underlying index, like Nifty. For practical understanding, let’s take a case wherein Nifty shows 100 points movement, and the lot size stands at 50. The ATM options delta being closer to 0.49, the gain here will be calculated as 49% of point movement, resulting in approximately 2450 (49*50) points. For the OTM options, the delta value is below 0.3. Standing at 30% of point movement, it would result in 1500 (<30*50) points, i.e., not attained the profitable zone yet.

As for the ITM options, the delta value is above 0.6. The gain, therefore, will be calculated as 60% of point movement, thereby resulting in gains exceeding 3000 (>60*50) points. The calculations help the traders to anticipate the potential gains, as per the option type they are holding and the underlying index movement. It guides them to make informed trading decisions.

5. Risk Level

Options trading includes the assessment of risks associated with varied moneyness levels and theta. ITM options offer immediate gains because of the higher delta, but they come with higher premiums that need substantial initial investment. It can limit profits if market conditions shift unfavourably. OTM options, on the other hand, yield some significant returns with quicker and more favourable market movements. They are riskier because of the lower delta and the higher theta decay. Lastly, ATM options having a delta near 0.49 offer a balanced risk-return profile.

Theta representing the time decay impacts the option’s value, with nearing expiry. The OTM options experience rapid decay due to heightening risks.

Due to this, traders must consider the impact of theta alongside market conditions and risk tolerance when choosing options that align with investment strategy. Understanding theta’s role further helps craft strategies that optimize potential returns while helping manage risks effectively.

6. Time Decay

Time decay is the rate at which the options lose the premium value over time when they approach expiration. The ATM options are time-based, and they experience significant decay. OTM options are highly susceptible to time decay as they lose their extrinsic value much more rapidly. ITM options, on the other hand, remain less affected because of their higher delta.

The ITM options also have a high likelihood of getting exercised as they offer immediate profit. Understanding the time decay is essential for traders as it influences the decision-making about when to sell or exercise options before the same expires.

7. Exercise Likelihood

The chance of the options being exercised depends on the moneyness, that is, how its strike price compares to the current market price. ITM options are highly likely to get exercised as they have in-built profit. OTM options are less likely to get exercised until one big market shift is in their favour. ATM options are in the middle of ITM and OTM options. They carry a moderate chance of getting exercised. Traders must consider all possibilities when planning strategies.

8. Cost Efficiency

Cost efficiency within options trading includes analysis of the relationship between the premium of the options and the potential return on the investment. The evaluation is essential when selecting the options. ITM options are expensive, but they offer more significant and immediate value. They are not just influenced by intrinsic value. OTM options, on the other hand, are cheaper and include high speculative risk. They can be profitable with the increased volatility.

Lastly, ATM options offer balanced costs and potential rewards. As volatility significantly impacts options’ pricing, ATM options are susceptible to volatility changes. Evaluating cost efficiency allows traders to optimize their portfolios and maximize returns while continuing to manage risk.

9. Impact of Volatility

Option pricing and profitability are greatly affected by implied volatility. This is because it reflects upon the market’s expectations for the underlying asset’s future price fluctuations. The ATM options are susceptible to changes in volatility, while the OTM options with significant volatility could become profitable. The ITM options, on the other hand, remain less impacted as the value is highly intrinsic. Understanding volatility and its impacts on pricing is essential for traders seeking to capitalise on the market’s movements.

10. Suitability

Suitability refers to how well the specific option aligns with the investment goals and a trader’s risk tolerance. ATM options are best for balanced strategies, while OTM options help cater to those who seek high risk or expect some significant market movement.

Lastly, ITM options are ideal for those prioritizing lower risk and certainty. Traders must evaluate these aspects carefully to ensure the options fit the broader investment strategy and the financial objectives.

What are ATM, OTM & ITM actually?

In option trading, ATM, OTM & ITM describe the relationship between the underlying asset’s current price and the option’s strike price. While ATM options carry intrinsic value with a balanced risk, OTM options remain speculative with the profit potential if the market makes a favourable shift, and ITM options, on the other hand, have intrinsic value with a high profitability likelihood.

At The Money (ATM) is an option where the underlying asset’s current price is equivalent to the strike price. The option doesn’t have intrinsic value, which means it cannot be exercised for profit at that time. ATM’s delta is typically around 0.5. It indicates balanced sensitivity to the change in price.

Out Of The Money (OTM) is the option when intrinsic value or profit is lacking. For the call option, the underlying asset’s price must be lower than the strike price of the asset. For the put option, the underlying asset’s price must exceed the strike price to become profitable. ITM options can be profitable if there is favourable movement in the market. However, due to its speculative nature, ITM has a lower delta.

In The Money (ITM) is an option when there is intrinsic value or a positive cash flow. The call option is ITM when the underlying asset’s price is higher than the strike price of the asset. A put option, on the other hand, is when the underlying asset’s price is lower than the strike price. ITM options could be exercised for immediate profit. These options generally have a higher delta. This indicates ITM’s greater sensitivity to market movement.

ITM, ATM, OTM: Which is Better?

In-the-money, At-the-Money, and Out-of-the-Money options offer unique benefits and drawbacks. Investors must carefully weigh them all. The decision about which options carry the most advantages is largely hinged on the investor’s specific strategy. It also depends on option traders’ strategy and the market outlook.

ITM options, in general, have intrinsic value and are less risky. Investors favour ITM options because of their potential to deliver substantial profits, which often come with a higher premium. The higher costs associated with ITM can be justified by its safer nature and its likelihood of achieving profitability.

ATM options are typically used by traders to capitalize on volatility with moderate risk. This makes them ideal for investors who believe significant price movements are on the horizon. They use a balanced approach by offering a mix of reward and risk, thereby making them suitable for strategies anticipating swings within market conditions.

Out Of The Money, however, is quite appealing because of the lower cost and the high leverage potential, albeit with the increased risk. The risk exists because the options aren’t intrinsically valuable during purchase. OTM options purchase lies in the ability of it to deliver some substantial return if there is a favourable market.

What is an Examples of ITM, OTM and ATM in Real-World Trading?

Let’s consider the Indian stock market, including Reliance Industries Limited (RIL). Suppose the stock of RIL is trading at ₹1200.

In the Money call option will have a strike price of ₹1200- the market price exceeds the strike price. It makes it profitable to be exercised. The difference between the strike price and the market price here represents an intrinsic value, making it an attractive choice for investors seeking immediate gains.

ATM call options will have a strike price of ₹1200 (approx.)- the exercising option will break even as it is approximately equal to the current market price. Investors might choose this option if they anticipate increasing the future stock price, offering them some potential gains.

OTM call options will have a strike price of ₹1300- the market price is below the strike price. It makes it unprofitable to exercise unless there is a rise in stock prices. However, it holds some potential if the investors expect the stock prices to rise, giving substantial profits if the market price surpasses the strike price.

How to Choose Between ITM, ATM, and OTM Options for Your Strategy?

Choosing between ITM, ATM, and OTM options for the strategy is dependent on varied factors, such as Market sentiment and volatility, time decay mechanisms, liquidity considerations, psychological factors, strategy alignment, and more.

Understanding broader market sentiment offers insights into which option will yield better results. For example, OTM options might provide a unique opportunity in a highly volatile market. In case of a significant price movement, they can provide substantial leverage despite high risks.

Concerning time decay dynamics, while most traders are focused on it being a negative factor for near-to-expiry options, it can be leveraged strategically. For instance, selling At the Money options will help capitalize on the time decay with collected premium income if a stock is anticipated to move sharply, unsure of its direction. The approach helps investors to profit from the decay as long as there isn’t any significant move in the stock.

ITM, ATM, and OTM options can have significantly variable market liquidity. ATM options generally offer high liquidity or tighter bid-ask spreads, which is advantageous for traders who wish to enter/exit positions quickly without incurring excessive costs.

Regarding psychological factors, traders exhibit behavioural biases, impacting their decision-making. For instance, the OTM option’s perceived riskiness makes some investors shy away, leading to potential opportunities within undervalued contracts. Recognizing such biases helps people make rational choices based on the data, not emotions.

Lastly, for strategy alignment, the strategy must dictate the investor’s choice of option. ITM options will be suitable for investors employing a hedging strategy because of their intrinsic value and the lower risk of total loss. However, OTM options will be an aggressive yet better choice if investors speculate on significant movement in the underlying asset.  

Investors could make informed decisions by considering some of the abovementioned factors and intrinsic and extrinsic value. Choosing between the options becomes more accessible.

What are the Risks and Rewards of Trading ITM, ATM, and OTM Options?

ITM, ATM and OTM options come with risks and rewards. Incorporating financial metrics helps further refine understanding, allowing traders to assess potential returns against market performance and volatility.

In-the-Money (ITM) Options

Risks

• High High Premium: ITM options demand a higher premium because of their intrinsic value, thereby making them costly. These options alpha show potential to outperform but are limited by the initial costs.
• Profit Potential: Despite being less risky, ITM options offer limited profit potential compared to the riskier strategies because of the high delta.
• Value: Approaching expiry might erode the value of ITM options lost, especially if they are static.
• Tax Implications: ITM options profits might incur taxes, affecting net returns.
• Liquidity: ITM options lack liquidity, complicating the trade execution. A higher beta indicates the volatility impacts.
• Volatility: Unexpected volatility leads to more significant than expected price swings, impacting options value.

Rewards

• High-Profit Probability: ITM options have an intrinsic value, which increases the likelihood of ending money. The value of it rises with the underlying asset’s price.
• Intrinsic Value: Built-in intrinsic value helps to have immediate profit upon the exercise.
• Less Risky: The breakeven point is close to the underlying asset’s price, reducing risk.
• Less Time Decay: ITM options are less affected by time decay, maintaining their value as the expiration nears. 

Out Of The Money (OTM)

Rewards

• Cost Efficiency: Lower costs, due to the lack of intrinsic value, allow for leveraging alpha for larger returns with smaller investments. 
• More considerable Gains: The potential for more significant gains exists with similar price movements. 
• Reduced Price: Priced lower than options, with a closer strike price to the current market price.
• Calculated Risk: Options offer traders a calculated risk profile compared to alternative strategies.
• Flexibility: Offers varied strategies like speculation and heading.
• High leverage: Lower premiums enable better control over the more significant assets with smaller investments.

Risks

• Higher Risk: OTM options are likely to expire worthless, causing a total loss of premium. A high beta indicates market susceptibility— an opportunity or a risk.
• Needs Significant Market Moves: Options need substantial price movement for profitability.
• Time Value Decay: Value diminishes over time, requiring the reliance upon beta and alpha.
• Limited Profit: Higher returns but limited profit potential, as price movements can be incremental, preventing favourable market shifts.
• Higher Volatility Risks: Sensitivity to market volatility change impacting value and increasing expiring worthless likelihood or costlier exits.

At The Money (ATM)

Rewards

• Lower Costs: The lack of intrinsic value makes the option affordable.
• Liquidity: Higher liquidity allows easier transactions.
• Limited Risk: Moderate data of approx. 0.5 offers a balanced price sensitivity.

Risks

• Limited Profitability: No intrinsic value creates a limit over the profit potential.
• Time Decay: A higher decay rate could erode the value quickly without the asset moving significantly.

What are the Common Mistakes to Avoid When Choosing ITM, ATM, and OTM Options?

When choosing ITM, ATM and OTM, there are some common mistakes to avoid. A discussion if it is made below to help you refine strategies while improving the chance of consistent gains.

Ignoring Plans: Failing to adhere to a trading plan can cause emotionally driven decisions and substantial losses. Emotions like frustration can cloud traders’ judgment to make impulsive decisions instead of following strategy. Maintaining discipline and setting clear exit strategies will help minimize losses and improve profit consistency.

Avoiding Liquidity: Liquidity is essential in trading. It impacts how assets can be bought/sold without impacting price. Lower liquidity can complicate trade execution while increasing price fluctuation risks. The traders must focus on high-volume contracts and effectively use limit orders to manage risks.

Blind Expiration Dates: Choosing an expiration date with no careful thought erodes options over time. Earning reports and other significant events can impact stock prices. The traders must avoid holding the contracts in such events. Traders must stick to strategies for long-term success.

Ignoring Probability’s Power: Ignoring the probability within options trading impairs risk management. The longer expiration dates are less risky, while the OTM contracts have higher risks. Understanding probability charts and the potential outcomes helps traders accurately assess risks, thereby making informed decisions.

Strike Price Inappropriate Selection: Selecting the wrong strike price for the expected market move will result in a loss. To say, OTM options might be appealing because of their low cost. However, they will need significant market movement to become profitable.

By avoiding the above-discussed five common mistakes, the options trader avoids potential losses, maximising the probability of a successful trade

Are ITM options always better than OTM options?

No, ITM options are not always better than OTM options. Their suitability is based on investors’ strategy. ITM options offer better security, but OTM options provide significant returns when there is anticipated price movement. Either way, choosing which is better- ITM or OTM depends on trading strategy goals and the risks the traders are willing to tolerate.

ITM options trading’s advantage is that even slight stock movement generates profit in the options contract. The disadvantage is that they cost more and stronger opposite-direction movement can create losses.

OTM options trading advantage is that it costs less, and gains made offer a high rate of return on the trading capital. The disadvantage is that underlying shares are to make a significant move for the OTM contract to offer the desired profit level.

Can OTM options become ITM before expiration?

Yes, on a positive note, OTM options can become ITM before their expiration. This happens when the underlying asset’s price moves favorably above the strike price. Such potential transformation is quite appealing to traders who look to capitalize upon volatility. This is because it leads to substantial profits from smaller investments.