What is "Out of the Money" (OTM) in Options?
OTM options have zero intrinsic value—they're the "lottery tickets" of trading. High risk, potentially high reward.
Quick Summary
An option is Out of the Money (OTM) when it has zero intrinsic value. For calls: stock price < strike price. For puts: stock price > strike price. OTM options are cheap because they're pure speculation—the stock must move significantly before they become profitable.
In our last post, we talked about "In the Money" (ITM) options—contracts that have real, tangible value. They're the safe, reliable, and expensive choice.
But if you look at the options market, you'll notice that the vast majority of trading volume often happens in a different zone: the "Out of the Money" (OTM) zone.
Why? Because OTM options are cheap. They're the "lottery tickets" of the financial world. They offer the promise of turning a few hundred dollars into thousands. But what exactly are you buying?
The Definition: What Does OTM Mean?
THE CORE CONCEPT
An option is Out of the Money when it has Zero Intrinsic Value
This means that if you were to exercise the option right now, you would lose money compared to just trading the stock in the open market. It's purely a speculative bet on the future.
Logic: Why use your option to buy at $150 when you can buy in the market for $140?
Logic: Why use your option to sell at $90 when the market pays you $100?
The Math: Checking if You're OTM
Checking for OTM status is simple: is the strike price currently "unreachable"?
1. Call Options (The "Reach")
Why? You have the right to buy at $110. That right is currently worthless because the market price is only $100.
2. Put Options (The "Safety Net")
Why? You have the right to sell at $280. That's useless when the market is willing to pay you $300.
What Are You Actually Paying For?
If an OTM option has zero "Real Value" (Intrinsic Value), why does it cost money? Why isn't it free?
You're paying for Time and Possibility.
Option Value Composition
ITM Option
OTM Option
The price of an OTM option is made up of 100% Extrinsic Value:
- Time: You're paying for the time remaining on the clock.
- Volatility: You're paying for the chance that the stock might make a massive move before expiration.
Because OTM options are pure Extrinsic Value, they are the most vulnerable to Time Decay (Theta). Every day the stock doesn't move toward your strike, the value of your option evaporates rapidly.
Why Buy OTM Options?
Despite the risks, OTM options are incredibly popular for two main reasons:
1. Massive Leverage (The 10x Return)
Because OTM options are cheap, they offer the highest percentage returns.
Leverage Comparison
Stock moves from $100 → $110 (+10%)
*This is an illustrative example. Actual returns depend on Delta, time to expiration, IV changes, and other factors.
2. Cheap Protection
Want to protect your portfolio against a crash? You rarely buy expensive ITM Puts. Instead, traders buy cheap OTM Puts (e.g., 20% below the market price). It costs very little, but if a catastrophe happens, those cheap options can explode in value.
The Seller's Perspective
While beginners often love buying OTM options, many professionals prefer selling them.
The Statistic
Historically, a significant percentage of OTM options expire worthless because the stock never reaches the strike price.
The Strategy
Traders sell OTM Puts or Calls to collect premium (income), betting the stock stays within a normal range.
Frequently Asked Questions
Summary
"Out of the Money" means you're currently losing the race. You're behind.
- To make a profit, the stock doesn't just need to move—it needs to move significantly to cross into the profit zone.
- OTM options are low probability, high reward.
If You Buy OTM
You're a speculator looking for a big move. High risk, potentially high reward.
If You Sell OTM
You're the "casino" collecting bets from speculators. Probability is on your side.
