Moneyness of a Call option

Intrinsic value of an option is the basis for classifying an option. Moneyness of an option is a classification method that classifies each option strike based on how much money a trader will make if he were to exercise his option contract today. There are three broad classifications.

• In the Money (ITM)

• At the Money (ATM)

• Out of the Money (OTM)

This can be further classified as

• Deep In the money

• In the Money (ITM)

• At the Money (ATM)

• Out of the Money (OTM)

• Deep Out of the Money

Understanding these options, strike classification is very easy. All you need to do is calculate the intrinsic value. If the intrinsic value is a non-zero number, then the option strike is considered ‘In the money’. If the intrinsic value is zero, the option strike is called ‘Out of the money. The strike, which is closest to the Spot price, is called ‘At the money’. Let us take up an example to understand this well. As of today, the value of Nifty is 18,534, keeping this in perspective I’ve taken the snapshot of all the available strike prices (the same is highlighted within a green box) from NSE website. The objective is to classify each of these strikes as ITM, ATM, or OTM. We will discuss the ‘Deep ITM’ and ‘Deep OTM’ later.

As you can notice from the image above, there are multiple available strike prices to trade. We will first identify ‘At the Money Option (ATM)’ as this is the easiest to understand. ATM option is that option strike which is closest to the spot price. Considering the spot is at 18534, the closest strike is 18550. Having ascertained the ATM option (18550), we will proceed to identify ITM and OTM options. To do this, we will pick a few strikes and calculate the intrinsic value.

• 18400

• 18450

• 18500

• 18550

• 18600

• 18700

The spot price is 18550, keeping this in perspective the intrinsic value for the strikes would be – @ 18400

Intrinsic Value = spot- strike (in case of call option)

18550-18400= 150

Non zero value, hence the strike should be In the Money (ITM) option @18450

Intrinsic Value = 18550 -18450 = 100

Non zero value, hence the strike should be In the Money (ITM) option @18550

We know that Nifty is presently trading at 18534 which is closest to the spot price of 18550. So, we will not calculate its intrinsic value.

@ 18600

Intrinsic Value = 18550 – 18600

= – 50

Negative intrinsic value, therefore, the intrinsic value is 0. Since the intrinsic value is 0, the strike is Out of the Money (OTM).

@ 18700

Intrinsic Value = 18550-18700

= – 150

Negative intrinsic value, therefore, the intrinsic value is 0. Since the intrinsic value is 0, the strike is Out of the Money (OTM).

So, the key takeaways are

• All option strikes that are higher than the ATM strike are considered OTM

• All option strikes that are below the ATM strike are considered ITM

If you relook at the above image of option chain chart derived from NSE website you can notice that NSE presents ITM options with a pale yellow background, and all OTM options have a regular white background. Now let us look at two ITM options – 18500 and 18000. The intrinsic value works out to be 50 and 550, respectively (considering the spot is at 18550).

Higher the intrinsic value, deeper the moneyness of the option. Therefore 18000 strikes are considered as ‘Deep In the Money’ option and 18500 as just ‘In the money’ option. Observe the premiums for all these strike prices (highlighted in the red box). If you notice the premium decreases as you move from ‘Deep ITM’ option to ‘Deep OTM option’. In other words, ITM options are always more expensive compared to OTM options.

(The author is a homemaker, who dabbles in stock market investments in free time)