option moneyness Understanding itm and otm

Moneyness of a Put option

Let us go over the exercise to determine how strikes are seen as ITM or OTM for Put options. The snapshot below, on 8th May 2015, when Nifty’s spot value was 8202, shows the various strikes that are available for Put options.

As we can gauge from the strike prices ranging from 7100 to 8700, the nearest one to spot is 8200 and it is trading at Rs.131.35/-, making it distinctly an ATM option. Now, we will move to identify the ITM and OTM options.

Let’s choose several strikes above and below the ATM to judge their intrinsic value (or moneyness): ITM and OTM options. Let’s go with these strikes for evaluation.

1. 7500
2. 8000
3. 8200
4. 8300
5. 8500

@ 7500

We know that the calculation of the put option’s intrinsic value is determined by subtracting the spot price from the strike price.

Intrinsic Value = 7500 – 8200

= – 700

Since the intrinsic value of the put option is negative, it indicates that the option is out of the money (OTM).

@ 8000

Intrinsic Value = 8000 – 8200

= – 200

Since the intrinsic value of the put option is negative, it indicates that the option is out of the money (OTM).

@8200

8200 is already classified as an ATM option. Let’s skip this for now and move ahead. 

@ 8300

Intrinsic Value = 8300 – 8200

= +100

As the intrinsic value of the put option is positive, it indicates that the option is in the money (ITM).

@ 8500

Intrinsic Value = 8500 – 8200

= +300

As the intrinsic value of the put option is positive, it indicates that the option is in the money (ITM).

1. Therefore, we can generalise that all put options with strikes higher than the at-the-money (ATM) options are considered in the money (ITM)
2. While all put options with strikes lower than the ATM options are considered out of the money (OTM).

As you can observe, the price of ITM options is considerably higher than that of OTM options.

As you may be aware, Option Greeks are the market forces that act upon option strikes and have an effect on their premiums. Therefore, by categorizing them, we can get a better idea of how each Greek affects each type of option strike in terms of premium.

– The Option Chain

The Option chain is a widespread tool found on many exchanges and trading platforms. It serves as a quick reference guide, enabling you to recognise the different strikes available for a particular underlying, while organising them by their moneyness. Moreover, it also provides important information such as the last traded price (LTP), bid & ask prices, volume and open interest for each of the respective option strikes.

Here are some key observations to help you better understand the option chain:

1. 1. The underlying spot value is displayed as Rs.68.7/- (highlighted in blue).
2. 2. The Call options are positioned on the left side of the option chain.
3. 3. The Put options are positioned on the right side of the option chain.
4. 4. The strikes are arranged in ascending order at the centre of the option chain.
5. 5. Based on the spot value of Rs.68.7, the closest strike is 67.5, making it an at-the-money (ATM) option (highlighted in yellow).
6. 6. For Call options, options with strikes lower than the ATM options are considered in-the-money (ITM) options and have a pale-yellow background.
7.  For Call options, options with strikes higher than the ATM options are considered out-of-the-money (OTM) options and have a white background.
8. Put Options with a strike price above the ATM have a yellow background, as they are considered to be ITM.
9. Put Options with strikes below the ATM have OTM statuses, and have a white background.
10. The practice of using pale yellow and white backgrounds to distinguish between ITM and OTM options in NSE is specific to NSE and may not be universally adopted in other exchanges or platforms.