Out of the Money (OTM)
Key Takeaways
- A call option is out of the money when the stock price is below the strike price
- A put option is out of the money when the stock price is above the strike price
- OTM options have no intrinsic value and consist entirely of time value
- OTM options are cheaper but have a lower probability of expiring with value
Definition
Out of the money (OTM) describes an options contract that has no intrinsic value. A call option is out of the money when the current price of the underlying asset is below the strike price. A put option is out of the money when the current price is above the strike price.
Since OTM options have no intrinsic value, their entire premium consists of time value. This time value reflects the market's estimate of the probability that the option will move in the money before expiration. If the option remains OTM at expiration, it expires worthless and the buyer loses the entire premium paid.
OTM options are the least expensive options available for a given underlying asset and expiration date, making them attractive to speculative traders seeking maximum leverage. However, the majority of OTM options expire worthless, which is why selling OTM options is a popular income strategy.
How It Works
For a call option, being out of the money means the stock would need to rise before the option has any exercise value. If a stock trades at $48 and you own a call with a $50 strike price, the stock needs to rise above $50 just for the option to reach at the money, and further above $50 plus the premium paid to reach profitability.
For a put option, being OTM means the stock would need to fall. If a stock trades at $52 and you own a put with a $50 strike, the stock must drop below $50 for the put to gain intrinsic value. OTM puts are commonly used as insurance to protect stock positions against declines.
The further out of the money an option is, the cheaper its premium but the lower its probability of profit. The delta of an OTM option is less than 0.50 for calls and greater than -0.50 for puts. A call with a delta of 0.20, for instance, has roughly a 20% chance of expiring in the money. OTM options experience rapid time decay, especially in the final weeks before expiration.
Example
Suppose NVIDIA (NVDA) is trading at $880. A call option with a $920 strike price expiring in 30 days is $40 out of the money and might trade for $22. The entire $22 premium is time value. For this trade to be profitable at expiration, NVDA must rise above $942 ($920 strike + $22 premium), a move of over 7%. If NVDA stays at $880 or drops, the call expires worthless and the $2,200 investment (100 shares x $22) is lost entirely. A put option with an $850 strike would be $30 OTM and might cost $15, requiring NVDA to fall below $835 for profit.
Why It Matters
OTM options are important in the options market because they provide affordable access to speculative positions and hedging strategies. Many popular strategies, including iron condors, strangles, and vertical spreads, use OTM options to define risk and reduce cost.
For traders, understanding that most OTM options expire worthless is a crucial reality check. Studies show that roughly 60-80% of options expire worthless or are closed for less than the premium paid. This statistical edge is why many professional options traders focus on selling OTM options and collecting premiums rather than buying them.
Advantages
- Lower premium cost provides maximum leverage on a directional bet
- Limited risk to the premium paid regardless of how far the stock moves against you
- Useful for hedging portfolios against tail-risk events at a low cost
- Widely used in spread strategies to define risk and reduce capital requirements
Limitations
- Majority of OTM options expire worthless, resulting in a total loss of premium
- Entire premium is time value, which decays rapidly as expiration approaches
- Requires a large move in the underlying to become profitable
- Low delta means the option gains value slowly relative to stock price movement
Frequently Asked Questions
Related Terms
Browse more definitions in the financial terms glossary.