Speaker 1: 0:03

Welcome to the Options Trading Podcast. We're on a mission to empower individual investors with the knowledge they need. Join us as we break down complex topics into simple, step-by-step guidance for conservative options trading.

Speaker 2: 0:16

Today we're jumping into something really core to options trading.

Speaker 3: 0:20

That's right. We're talking about those terms. You always see in the money, at the money out of the money.

Speaker 2: 0:30

You know, ITM, ATM, OTM, yeah. What do they actually mean for the option itself?

Speaker 3: 0:32

And for you, the trader Exactly. If you've ever been confused by that, well, this deep dive is definitely for you.

Speaker 2: 0:36

We're basing this on an article, pretty straightforward one, called Understanding Options In, at and Out of the money. It lays things out nicely.

Speaker 3: 0:45

And our goal here it's to unpack ITM, atm, otm. Show how they connect the options strike price to the stock's current price.

Speaker 2: 0:53

And, crucially, why knowing this difference is well fundamental. Doesn't matter if you're buying or selling.

Speaker 3: 0:58

Absolutely essential knowledge.

Speaker 2: 1:00

Okay, let's get into it. Then, before we hit the specific states ITM, atm, otm we need to be absolutely clear on the two key prices involved.

Speaker 3: 1:08

Right, because everything hinges on the relationship between these two numbers. First, the strike price.

Speaker 2: 1:13

That's the fixed price in the option contract. Yeah, the price where the holder can buy a call or sell a put.

Speaker 3: 1:18

Exactly Fixed, locked in. And the second is the stock price or the underlying assets price.

Speaker 2: 1:24

Which is just where the stock is trading right now, live in the market.

Speaker 3: 1:29

And the whole ITMAT MOTM thing. It's just comparing those two the strike versus the current stock price.

Speaker 2: 1:36

It seems simple on the surface.

Speaker 3: 1:37

It is, but the implications are huge. Let's start with in the money ITM.

Speaker 2: 1:42

Okay, the source defines ITM basically as if exercising the option right now would make you a profit. We're ignoring the premium cost just for this definition.

Speaker 3: 1:52

Right. So for a call option, that's, the right to buy it's ITM when the stock price is higher than your strike price you get to buy cheaper than market.

Speaker 2: 1:58

Makes sense and for a put option, the right to sell. It's the opposite, it's ITM. When the stock price is lower than your strike price, you get to sell higher than market.

Speaker 3: 2:07

Let's use the article's examples Stocks trading at $60. You hold a call with a $50 strike.

Speaker 2: 2:12

Okay, Stock price $60 is higher than strike $50. So that call is ITM.

Speaker 3: 2:18

Precisely, and it's ITM by $10. That $10 difference, that's its intrinsic value.

Speaker 2: 2:23

Ah, okay, the real tangible value it has right now because of where the stock is relative to the strike.

Speaker 3: 2:29

Exactly Same stock at $60, but now you have a put with a $70 strike.

Speaker 2: 2:33

Okay, stock price $60 is lower than the strike $70. So the put is ITM.

Speaker 3: 2:38

Right again, and also by $10, $70 strike, $60 stock, that's its intrinsic value.

Speaker 2: 2:45

Got it, so ITM options have intrinsic value.

Speaker 3: 2:48

They do, and for buyers that's generally good right. The option already has some inherent worth.

Speaker 2: 2:53

Which is why they tend to be more expensive, I guess.

Speaker 3: 2:54

Generally yes.

Speaker 2: 2:55

Yeah.

Speaker 3: 2:56

Especially the deeper ITM they go, and the deeper ITM the more they act like the stock itself.

Speaker 2: 3:00

Right that delta gets closer to one. They move almost dollar for dollar with the stock. Less guesswork on direction needed. Maybe more about capturing that existing value plus any further move.

Speaker 3: 3:09

True. Now flip side for option sellers. Itm options are well, they're riskier.

Speaker 2: 3:15

Yeah, I can see why, If you sold that $50 call when the stock's at $60, you could be forced to sell your shares for $50 when they're worth $60.

Speaker 3: 3:23

Ouch, or if you sold the $70 put with the stock at $60, you might have to buy shares at $70 that you could get for $60.

Speaker 2: 3:30

So a much higher chance of being assigned the stock Definitely.

Speaker 3: 3:33

Higher probability of assignment usually requires more capital, more margin held by your broker.

Speaker 2: 3:38

The article had a joke about selling naked ITM calls. Oh, I think about skydiving.

Speaker 3: 3:43

Yeah, like selling an in the money naked call. It's a bit like volunteering to catch a falling knife Possible, you won't get hurt. But why risk it unless you absolutely have to or you know you have a very specific strategy, like already owning the stock for a covered call.

Speaker 2: 3:58

Okay, paints a picture. So that's. Itm has intrinsic value. Now, what about when there's no intrinsic value right now at the money?

Speaker 3: 4:05

At the money ATM. This is super simple conceptually. The strike price is basically the same as the current stock price, or very, very close.

Speaker 2: 4:13

Stocks are $50. The strike is $50. Call or put. That's ATM.

Speaker 3: 4:16

Exactly, and the key thing here ATM options have zero intrinsic value. Their price is all extrinsic value.

Speaker 2: 4:24

Extrinsic value, that's the time value right, Based on how much time is left, how jumpy the stock might be.

Speaker 3: 4:29

Time to expiration implied volatility. That's the market's guess about future swings, often called vega and just general market expectations. It's the premium for the possibility of the option becoming ITM later.

Speaker 2: 4:41

And, interestingly, atm options usually have the most extrinsic value, right yeah, compared to ITM or OTM for the same expiration.

Speaker 3: 4:48

That's typically the case. It's where the uncertainty is highest. You could say the stock only needs a small nudge to become ITM in either direction.

Speaker 2: 4:56

So they're really sensitive to price changes.

Speaker 3: 4:58

Very sensitive. We talk about high gamma for ATM options. That means their delta, how much the option price changes for a $1 stock move can change very quickly if the stock starts moving.

Speaker 2: 5:09

Ah, okay, so for buyers, atm might be attractive if you expect a big, fast move. Often, yes, they're cheaper than ATM options, give you leverage and react quickly.

Speaker 3: 5:21

But there's a patch Time decay, theta Exactly. Since their value is all extrinsic, they are losing value every single day due to time decay, and ATM options lose it fastest If the stock just sits there. That premium melts away.

Speaker 2: 5:33

The article compares it to a gym membership.

Speaker 3: 5:35

Huh, yeah, you pay for the potential to get fit, but if you don't actually show up and work out, if the stock doesn't move, you're just losing money as time ticks by.

Speaker 2: 5:43

It's a bit close to home. So for buyers, high sensitivity potential for big games if it moves, but theta risk is significant Precisely.

Speaker 3: 5:53

For sellers, though, ATM options offer the highest premium up front.

Speaker 2: 5:57

Because of all that extrinsic value.

Speaker 3: 5:59

Right. So it's tempting to sell them to collect that premium.

Speaker 2: 6:02

But the risk is high too, isn't it? A small move makes it ITM against you pretty fast.

Speaker 3: 6:06

Absolutely High directional risk. Sellers often use ATM options and strategies where they bet the stock won't move, much like short straddles or iron condors.

Speaker 1: 6:18

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Speaker 2: 7:00

Okay, ITM has intrinsic ATM, has max, extrinsic, high sensitivity, high decay. That leaves out of the money OTM.

Speaker 3: 7:08

OTM. This means exercising the option right now would be a losing proposition. It wouldn't make sense, based purely on strike versus stock price.

Speaker 2: 7:16

So for a call. The strike price is higher than the current stock price. Like stocks at $40, strikes at $50.

Speaker 3: 7:22

Correct. You wouldn't exercise your right to buy at $50 when the market price is $40.

Speaker 2: 7:27

And for a put the strike price is lower than the stock price. Stock at $40, put strike at $30.

Speaker 3: 7:33

Yep, you wouldn't exercise your right to sell at $30 when you could sell for $40 in the market.

Speaker 2: 7:38

So, just like ATM options, otm options have zero intrinsic value.

Speaker 3: 7:43

Correct their entire price. Whatever it is, is pure extrinsic value. It's payment for the chance, however small, that the stock might move enough before expiration to make it ITM.

Speaker 2: 7:54

Now for buyers. The big appeal of OTM options is they're cheap.

Speaker 3: 7:58

They're the cheapest, yeah, and because they're cheap, they offer the most leverage. A small amount of money controls the potential outcome of 100 shares If the stock makes a massive unexpected move in your favor.

Speaker 2: 8:10

The payoff can be huge percentages.

Speaker 3: 8:12

Potentially yes, but and it's a big but- they're the riskiest. By far Most OTM options expire worthless. The further OTM they are or the less time they have left, the lower the probability they'll ever become profitable.

Speaker 2: 8:26

So buyers use them for what Speculation Hail Mary plays or maybe cheap hedging sometimes.

Speaker 3: 8:30

All of the above. High risk speculation is common. You accept the high likelihood of losing your premium for that small chance of a massive return, sometimes used for hedging disaster scenarios too, because the cost is low.

Speaker 2: 8:44

The lottery ticket analogy often comes up here.

Speaker 3: 8:46

It fits pretty well Low cost, very low probability, but a huge jackpot if you win Now. For sellers, otm options are often the bread and butter.

Speaker 2: 8:56

Ah, because the odds are high, they will expire worthless.

Speaker 3: 8:58

Exactly. Sellers collect the premium up front and since the probability of the option ending up ITM is lower, they have a higher statistical chance of keeping that premium as profit.

Speaker 2: 9:08

That's where strategies like selling OTM puts for income or selling OTM covered calls against stock you own come in.

Speaker 3: 9:15

Precisely, you're playing the probabilities, trying to collect theta decay.

Speaker 2: 9:18

But it's not zero risk for the seller, right yeah, the source mentions risk management is still key.

Speaker 3: 9:24

Absolutely not zero risk.

Speaker 1: 9:27

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Speaker 3: 9:59

While the probability of any single OTM option causing a loss might be low, a sudden sharp adverse move in the stock can happen and if it does, an OTM option can suddenly become ITM and the potential loss for the seller can be substantial, especially on naked options. So managing position size and overall risk is crucial.

Speaker 2: 10:18

Right, you're betting against the long shot, but the long shot sometimes comes in. You have to be prepared for it. Okay, let's pull this all together then. Why does this ITM, atm, otm distinction matter so much day to day?

Speaker 3: 10:29

Because it fundamentally defines the options characteristics, its value, composition, intrinsic versus extrinsic, dictates its price behavior, its sensitivity to stock moves and time decay, and the probabilities involved. So quick recap ITM means stock strike, atm means stock strike, otm means stock strike.

Speaker 2: 10:45

And for puts ITM means stock strike, atm means stock strike, otm means stock strike.

Speaker 3: 10:50

And the value ITM has intrinsic value. Atm is all extrinsic most sensitive, fastest decay. Otm is all extrinsic cheapest. Highest leverage for buyers, highest probability of expiring worthless for sellers.

Speaker 2: 11:03

Knowing which state an option is in tells you what you're actually trading. Are you trading existing value? Are you trading time and volatility? Are you trading a low probability outcome?

Speaker 3: 11:13

It impacts your strategy choice, your risk assessment, your potential reward, basically everything.

Speaker 2: 11:19

Think about it from the buyer's perspective. Do you want the higher probability but higher cost of IPM, the sensitivity and decay risk of APM, or the low cost? Low probability, high leverage of OTM.

Speaker 3: 11:31

And for sellers are you taking assignment risk with ITM, high directional risk with ATM for higher premium or playing the probabilities with OTM for lower premium but maybe better odds?

Speaker 2: 11:43

Understanding this helps you align your trades with your market view and risk tolerance. Or playing the probabilities with OTM for lower premium but maybe better odds. Understanding this helps you align your trades with your market view and risk tolerance. It helps avoid nasty surprises near expiration when, say, an OTM option suddenly raises ITM or an ATM option's value evaporates due to theta.

Speaker 3: 11:55

And it's dynamic right. An option state isn't fixed.

Speaker 2: 11:58

Not at all. As the stock price moves, options constantly shift between OPM, ATM and ITM, and time passing always works against the extrinsic value component.

Speaker 3: 12:06

So here's a thought to leave you with when you look at an option chain, think about which state ITM, atm or OTM actually aligns with your specific goal for that potential trade. Are you buying for leverage, selling for income Hedging?

Speaker 2: 12:21

And how might that state change? If the stock moves up $5 or down $5, or if a week passes, what happens to your options characteristics then?

Speaker 3: 12:30

Understanding that dynamic is key that's the deeper level, beyond just the definitions. Definitely All right. That wraps up our deep dive into in the money, at the money and out of the money. Thanks for joining us.

Speaker 2: 12:41

This is an AI podcast based on educational material from Option Genius. Visit us today at optiongeniuscom.