What is Out of the Money (OTM)?
"Out of the money" describes an option that is worthless if exercised today. In the case of a call option, the option has no intrinsic value because the current price of the underlying stock is less than the option strike price.
In the case of a put option, the option is considered out of the money when the price of the underlying stock is higher than the option strike price.
How Does Out of the Money (OTM) Work?
Let’s assume IBM (NYSE:IBM) stock trades at $100 and an investor purchases a call option contract on IBM at a $102 strike price. If IBM closes below $102 on the contract expiration date, the option expires out of the money. The option is worthless since the option buyer would lose money by exercising the option.
Likewise for a put option, assuming IBM stock trades at $100 and an investor purchases a put option contract on IBM at a $97 strike price. If IBM closes above $97 on the contract expiration date, the option expires out of the money. The option is worthless since the option buyer would lose money by exercising the option.
Why Does Out of the Money (OTM) Matter?
In general, having an out of the money option is not desirable. However, losing the premium paid to purchase the option is almost always better than losing the value of the underlying stock. This is one reason options are commonly used for hedging existing investments.
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