Determining In, At, and Out-of-the-Money Option Values
There are primarily three ways to state the value of an option. These include options that are in-the-money, at-the-money, and out-of-the-money. These terms refer to the actual relationship between the current market price of the underlying stock shares as well as the strike price of the option.
An option that is at-the-money means that the options strike price is the same as the current market price of the underlying stock shares. For example, if the current share price of XYZ stock is $25 and an investor has a $25 call or put option, then that investor has an option that is at-the-money.
At-the-money options will always have the highest amount of time value associated with them. This is because at the underlying stock price, the option does not give the investor any edge or intrinsic value. Thus, the price of the option at this point is purely based on it time value. This time value, however, will tend to decay as the option moves closer to its expiration, especially if the price of the underlying stock does not move in a desired direction.
Out-of-the-money options have differing meanings depending upon whether an investor has a call or a put. For instance, an out-of-the-money call option will have a strike price that is higher than the current stock price. Therefore, if the current price of the underlying stock shares is $20 - that will make a $30 call option an out-of-the-money option.
Conversely, an option that is out-of-the-money will have a strike price that is below the current price of the underlying shares of stock. Thus, if the current price of the underlying stock is $20 per share, then that will make a $10 put option an out-of-the-money option. And, similar to at-the-money, an out-of-the-money option will not have any intrinsic value because if the option is exercised, then it will only generate a loss to the investor.
In-the-money options are completely the opposite of out-of-the-money and at-the-money options. For example, with a call option, the strike price will be lower than the current price of the underlying stock shares. An in-the-money option will hold intrinsic value because at the point of its exercise, the investor may purchase the underlying stock at a price that is lower than its market price.
There are also several factors in the market that come into play with regard to how options are priced. One such criteria is the supply and demand in the market where that option is traded. This can be looked at as being similar to the price determination for individual stock shares.
Other factors that can affect the price of an option is what is occurring in the overall investment markets and the economy at large. Still other determinants can include the identity of the underlying instrument, how it typically behaves, and what it is doing at a specific point in time. Also, volatility is another important factor in the price of an option, as investors attempt to gauge how likely it is that an option will move towards being in- or out-of-the-money.