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 a recent date, when Nifty’s spot value was 24,600, shows the various strikes that are available for Put options. In it, you’ll notice the strike prices on the left are emphasised with a blue box.

As we can gauge from the strike prices ranging from 22,800 to 26,400, the nearest one to spot is 24,600 and it is trading at Rs 185.50, 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:

23,200

24,200

24,600

25,000

25,800

At 23,200:

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 = 23,200 – 24,600

= -1,400

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

At 24,200:

Intrinsic Value = 24,200 – 24,600

= -400

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

At 24,600:

24,600 is already classified as an ATM option. Let’s skip this for now and move ahead.

At 25,000:

Intrinsic Value = 25,000 – 24,600

= +400

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

At 25,800:

Intrinsic Value = 25,800 – 24,600

= +1,200

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

Therefore, we can generalise that all put options with strikes higher than the at-the-money (ATM) options are considered in the money (ITM)

Whilst 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 categorising 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, whilst 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.

Let’s assume this is the option chain of Maruti Suzuki as published on NSE:

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

The underlying spot value is displayed as Rs 12,850 (highlighted in blue)

The Call options are positioned on the left side of the option chain

The Put options are positioned on the right side of the option chain

The strikes are arranged in ascending order at the centre of the option chain

Based on the spot value of Rs 12,850, the closest strike is 12,850, making it an at-the-money (ATM) option (highlighted in yellow)

For Call options, options with strikes lower than the ATM options are considered in-the-money (ITM) options and have a pale yellow background

For Call options, options with strikes higher than the ATM options are considered out-of-the-money (OTM) options and have a white background

Put Options with a strike price above the ATM have a yellow background, as they are considered to be ITM

Put Options with strikes below the ATM have OTM statuses, and have white backgrounds

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

For those exploring equity investment opportunities through a stock broker or consulting with a financial advisor, understanding put option moneyness proves essential when navigating the stock market. Whether evaluating trading calls or utilising a stock screener to identify opportunities, comprehending the option chain and strike classifications enables more informed put option selection.

Visit https://stoxbox.in/ for comprehensive educational resources on option chains and moneyness analysis tools.