What does it mean to say that an option is out of the money?

Its expiration date has passed without exercise, so the holder's right to buy or sell has lapsed

Exercising it now would leave its holder worse off than dealing in the shares directly in the market

Its writer may now cancel the contract by handing back the premium that the holder paid for it

Exercising it now would give the holder a gain, though one too small to cover the costs of exercise

An investor bought a call with a forty-five-dollar strike for two dollars when the stock traded at forty-one. The stock now trades at forty-three and the call's premium is two dollars sixty. Which two figures decide whether the call is out of the money now?

Forty-one and forty-five: the stock's price when she bought, set against the call's strike

Two dollars sixty and two dollars: the call's premium now, set against the premium paid

Forty-three and forty-five: the stock's price now, set against the call's strike

Forty-three and forty-one: the stock's price now, set against its price when she bought

A call has a strike price of ninety dollars and the stock trades at eighty-six. The call's premium is one dollar seventy-five. How is the premium made up?

All of it is time value, since buying at ninety would gain nothing against eighty-six

All of it is intrinsic value, a premium counting as intrinsic until the option is exercised

Mostly intrinsic value, measured by the four-dollar gap between the strike and the stock

Mostly time value, with a few cents of intrinsic value as the stock nears the strike

A put is out of the money when trading opens. At midday the stock crosses the put's strike price and stays on the other side of it until the close. When does the put's moneyness change?

When the holder notifies her broker-dealer, a change of state needing to be declared

As soon as the stock crosses the strike, moneyness following the price through the day

When the stock has moved a full strike interval past the strike, not a cent sooner

At expiration only, an option's moneyness being judged on that one day alone

A call and a put on the same stock both have a strike price of thirty-five dollars, and the stock trades at exactly thirty-five. Which of the two is out of the money?

The put only, a put level with its strike standing out of the money

The call only, a call level with its strike standing out of the money

Neither of them, an option level with its strike standing at the money

Both of them, an option level with its strike standing out of the money

A call and a put on one stock share the same strike price and expiration, and the stock trades some way from that strike. How do the two options stand?

Both stand in whatever state the call is in, a put taking its moneyness from the call

Both are out of the money, neither being worth exercising until the stock returns to the strike

Both are in the money, each of them gaining value the further the stock moves away from the strike

One is out of the money and the other in, whichever way the stock has moved

A call has a strike price of eighty-five dollars and the stock trades at seventy-nine. What would exercising the call now mean for its holder?

Paying eighty-five dollars a share for stock the market is selling at seventy-nine

Selling at eighty-five dollars a share stock that the market is buying at seventy-nine

Buying at seventy-nine, the market price, and receiving the six-dollar gap from the writer

Paying eighty-five a share and recovering the premium paid for the call from the writer

A call has a strike price of forty-two dollars fifty and the stock trades at thirty-eight dollars. How does the call stand?

In the money by four dollars fifty, the amount the strike stands above the stock

Out of the money by four dollars fifty, the amount the strike stands above the stock

Out of the money by thirty-eight dollars, the whole of the stock's current market price

In the money by thirty-eight dollars, the value of the share that the call would deliver

A speculator pays forty cents a share for a call struck at fifty dollars. At expiration the stock closes at fifty-four dollars. What is her net gain per share, and how does it compare with the premium she paid?

Three dollars sixty, but only ninety percent of the premium she paid for the call

Four dollars, ten times the premium she paid, the premium not being deducted from the gain

Three dollars sixty, nine times the premium she paid for the call

Forty cents, the premium, since a call finishing in the money returns only what was paid for it

A put has a strike price of $27.50 and the stock trades at $31.00. How does the put stand?

In the money by $31.00, the market value of each share the put would sell

In the money by $3.50, the market price lying that far above the strike

Out of the money by $27.50, the whole of the strike price the put carries

Out of the money by $3.50, the market price lying that far above the strike

An investor owns one hundred shares trading at fifty-two dollars and holds a put on them with a strike price of forty-six dollars. She has decided to sell the shares today. How should she sell them, and why?

In the market, which pays her six dollars a share more than exercising the put would

By exercising the put, which pays her six dollars a share more than the market would

By exercising the put, which returns the premium she paid on top of the strike price

By exercising the put, as shares held with a put must be sold through it before expiry

A put has a strike price of fifty-five dollars and the stock trades at sixty-two, with a month left to expiration. The stock then rises to sixty-eight, and nothing else about the put changes. What happens to the put's price?

It rises, since every option on a stock moves in the same direction as the stock itself does

It falls, since a put's price moves in the opposite direction to the stock's price when the stock rises

It is unchanged, since an out-of-the-money put's price does not move until the stock crosses its strike

It rises, since a rising stock makes the right to sell at a fixed strike more valuable to its holder

Two calls on the same stock have the same strike price, and both are out of the money. One expires in three months and the other in one week. All else equal, which carries more time value, and why?

Neither, time value depending on the strike's distance from the stock, which the two share

The one-week call, its nearer expiry making a payoff more certain and so worth more

The three-month call, which gives the stock far more time to move above the strike

Neither, the two calls carrying equal time value until the final month before expiry

Two stocks each trade at seventy dollars, and each has a call with a seventy-eight-dollar strike and the same expiration. The options on stock A carry much higher implied volatility than those on stock B. How do the two calls' premiums compare?

A's call costs more, though not until A's stock has risen to within reach of the strike

B's call costs more, a steadier stock being likelier to drift up toward the strike

They cost the same, the two calls sharing a strike, an expiration and a stock price

A's call costs more, a move large enough to pass the strike being likelier for A

In the pricing of an option, what does the underlying security's implied volatility express?

The market's expectation of how much the stock will fluctuate over the option's remaining life

The average daily change in the stock's price since the option was first listed for trading

The rate at which the option's time value wears away with each day that passes until expiry

The amount by which the stock must move to carry the option into the money before expiry

A stock trades at thirty dollars. Two calls on it share an expiration: one has a strike price of thirty-one dollars fifty and the other a strike price of forty-five. Which call costs less, and why?

The thirty-one-fifty call, its strike lying closer to the price at which the stock now trades

The forty-five-dollar call, the stock having to move much further to put it in the money

Neither, calls sharing an expiration on one stock being priced the same at every strike

The forty-five-dollar call, a higher strike carrying a lower price under the exchange's fee schedule

A speculator buys deep out-of-the-money calls whose premium is small beside the price of the shares. What does the low premium mean for the risk she takes on?

Her risk is slight, the low premium reflecting a high chance that the calls will pay off

Her loss can run past the premium if the stock falls, as she must then buy at the strike

Her loss cannot exceed the small premium, yet the chance of the calls paying off is low

Her loss is capped at half the premium, the writer refunding the rest if the calls lapse

A trader buys deep out-of-the-money calls expiration after expiration as a speculative strategy. What is typically true of the strategy's probability-weighted expected value for her?

It is typically positive once held to expiration, the time value being recovered then

It is typically positive, the large percentage gains outweighing the small premiums lost

It is zero, the low premiums being set exactly at the fair odds of a payoff arriving

It is typically negative, the rare large gains not making up for the premiums lost

Two investors each wrote a put on the same stock for the same premium. At expiration one put is one dollar out of the money and the other is twenty dollars out of the money. How do the two writers' gains compare?

They are equal, since each writer keeps the premium in full however far out of the money her put expired

The writer of the put twenty dollars out of the money gains more, the extra distance adding to her profit

The writer of the put one dollar out of the money gains more, since it still holds some time value at expiration

The writer of the put one dollar out of the money gains less, a put finishing so near its strike costing her part of the premium

An investor buys five call contracts at a premium of eighty cents a share, each contract covering one hundred shares. At expiration the calls are out of the money. What has she lost?

Eighty dollars, the premium on one contract being the most she can lose

Four hundred dollars, the whole of what she paid for the five contracts

Two hundred dollars, the calls keeping half their value at expiration because time value never fully lapses

Nothing yet, a loss being realised only when she sells the calls herself

An investor wrote a put that expires out of the money. What obligation does she still have under the contract?

To stay ready to buy at the strike until the next expiration cycle has begun

To buy the shares at the strike if the holder files exercise notice within a week

None: no assignment comes, the holder having no right that is worth exercising

To buy the put back from the holder at its final quoted price before settlement

A holder owns an equity call with a strike price of thirty dollars. The stock closes at thirty dollars and one cent on the expiration day, and the holder gives no instructions. What happens to the call?

It is exercised automatically, but only after the holder's firm confirms it the next morning

It lapses unexercised, automatic exercise needing a close a full dollar past the strike

It lapses unexercised, a one-cent gain being too small to count as in the money

Automatic exercise follows, the close leaving it a cent a share in the money

On the expiration day a stock trades as high as fifty-two dollars thirty during the session, then closes at forty-nine dollars ninety. The holder of an equity call with a fifty-dollar strike gives her broker-dealer no instructions. What happens to the call?

It expires worthless, the close leaving it ten cents out of the money whatever the session high had been

It is exercised automatically, the session high having carried it into the money during the day

It is exercised automatically, since it closed within a dollar of the strike and so counts as in the money

It lapses only because the holder gave no instructions, and with instructions it would have been exercised

A put is five dollars in the money three weeks before expiration, and its holder has given her broker-dealer no instructions. On that day, does the OCC's exercise-by-exception procedure exercise the put automatically?

Yes, since the procedure exercises any in-the-money option automatically from the moment it goes in the money

No, the procedure's automatic exercise operates at expiration and not on the days before it

Yes, but only after her broker-dealer has asked her to confirm the exercise on the next trading day

No, since the procedure exercises only calls and leaves an in-the-money put to its holder to exercise

GHI stock trades at forty-eight dollars. What would exercising a GHI forty-five call now do for its holder?

Leave her no better or worse off than the market does, the stock costing forty-eight dollars a share on either route

Buy at forty-eight dollars a share stock that the strike prices at forty-five, a three-dollar loss a share before the premium

Sell at forty-five dollars a share stock that the market would buy at forty-eight, a three-dollar loss a share before the premium

Buy at forty-five dollars a share stock the market prices at forty-eight, a three-dollar gain a share before the premium

An investor buys a call that is well out of the money, and another investor writes it. Over the following weeks the stock stays far below the strike price and nothing else changes. As time passes, whose position gains?

The writer's, because the call's price, all of it time value, falls while the stock stays far from the strike

The buyer's, because the call is worth more to its holder with each day that brings it nearer to expiration

Neither, because an out-of-the-money option's price depends only on the stock's price and not on the time left

Both equally, because the premium the buyer paid is exactly the premium the writer received and stays so

Three calls on one stock share an expiration date: one is deep in the money, one at the money and one out of the money. All else equal, how do their total premiums rank?

The at-the-money call's is highest and the in-the-money call's lowest

The in-the-money call's is highest and the out-of-the-money call's lowest

The out-of-the-money call's is highest and the at-the-money call's lowest

The at-the-money call's is highest and the out-of-the-money call's lowest

Of the three moneyness states, at-the-money options typically carry the most time value. What explains this?

Their time value wears away more slowly than other options' does as expiration nears

Their strikes are set by the exchange so as to carry the most premium for market makers

Small moves either way decide whether they end with value, the chance being about even

Buyers expect them to finish deep in the money and pay in advance for that expectation

Two days before expiration a stock trades at twenty-nine dollars, and a call on it has a strike price of forty-five. What is the call likely to trade for?

Its original premium, its time value holding steady until the last day of trading

About sixteen dollars, the gap between the stock and the strike being priced into it

Nothing, an out-of-the-money call being barred from trading in its final week

A few pennies, the chance of the stock reaching forty-five in two days being negligible

Out of the Money (OTM): Definition, Calls, Puts, and Premium

Out of the Money

Out of the money — universally abbreviated OTM — is the term used to describe an option contract that has no intrinsic value because the relationship between the current market price of the underlying security and the option's strike price is unfavourable to the holder — meaning that exercising the option right now would produce a loss relative to transacting directly in the market. As confirmed by tastylive's options education resource, out of the money describes an option that has zero intrinsic value, with any and all value in an OTM option consisting entirely of extrinsic — time — value. Understanding out of the money and its relationship to in the money, at the money, intrinsic value, and time value is among the most directly and consistently tested concepts on the SIE and Series 7 examinations.

The Three States of Moneyness

Every option at every moment exists in one of three states — called moneyness — that describe the relationship between the underlying security's current market price and the option's strike price. These three states are not fixed characteristics of the option. They change continuously as the underlying security's price moves throughout each trading day.

In the money means the option has intrinsic value — exercising it immediately would produce an economic benefit. At the money means the underlying security's current market price equals the strike price exactly — intrinsic value is zero. Out of the money means the option has no intrinsic value — exercising it immediately would produce an economic loss, and no rational investor exercises an OTM option.

These three states apply differently to calls and puts because calls and puts are the mirror image of each other. The condition that makes a call in the money — the market price above the strike — is exactly the condition that makes a put out of the money. The condition that makes a put in the money — the market price below the strike — is exactly the condition that makes a call out of the money. Candidates who keep this mirror image relationship in mind will answer moneyness questions with complete reliability.

Out of the Money Calls

A call option is out of the money when the current market price of the underlying security is below the strike price. The call gives its holder the right to buy at the strike price — but when the market price is below the strike, buying at the strike means paying more than the market currently offers. No rational holder exercises an out-of-the-money call, because they can buy the same shares more cheaply in the open market than by exercising the option.

A call with a sixty dollar strike price when the underlying stock trades at fifty-four dollars is out of the money by six dollars. The holder of this call would not exercise — exercising would mean paying sixty dollars for stock worth fifty-four dollars, an immediate six dollar per share loss before even accounting for the premium paid. The option has no intrinsic value. Its entire premium — whatever it commands in the market — consists purely of time value reflecting the probability that the stock price rises above sixty dollars before expiration.

The mnemonic used throughout the Series 7 curriculum is call up — calls go in the money when the market price goes up above the strike. Conversely, calls are out of the money when the market price is down below the strike.

Out of the Money Puts

A put option is out of the money when the current market price of the underlying security is above the strike price. The put gives its holder the right to sell at the strike price — but when the market price is above the strike, selling at the strike means receiving less than the market currently offers. No rational holder exercises an out-of-the-money put, because they can sell the same shares at a higher price in the open market than by exercising the option.

A put with a forty-five dollar strike price when the underlying stock trades at fifty-two dollars is out of the money by seven dollars. The holder would not exercise — exercising would mean selling at forty-five dollars stock worth fifty-two dollars, an immediate seven dollar per share loss. The option has no intrinsic value. Its entire premium consists purely of time value.

The mnemonic is put down — puts go in the money when the market price goes down below the strike. Conversely, puts are out of the money when the market price is up above the strike.

The OTM Premium — Pure Time Value

An out-of-the-money option's premium consists entirely of time value — also called extrinsic value — with zero intrinsic value. This is the defining characteristic that distinguishes OTM options from in-the-money options, which have premiums consisting of both intrinsic value and time value.

Time value reflects two primary factors. The first is time remaining to expiration — the more time before expiration, the more opportunity the underlying price has to move favourably and carry the option into the money. A three-month OTM call carries substantially more time value than a one-week OTM call at the same strike price, because the three-month contract has far more opportunity for the underlying to move favourably.

The second factor is implied volatility — the market's expectation of how much the underlying security will fluctuate in price over the remaining life of the option. Higher implied volatility means larger expected price swings, which increases the probability that the underlying will move sufficiently to carry even a deeply OTM option into profitable territory before expiration. Options on high-volatility stocks carry higher time value premiums than options on stable, low-volatility stocks at equivalent strike distances, because the probability of a large favourable move is greater.

This is why OTM options are cheaper than comparable in-the-money options. An OTM option's value is entirely contingent on a favourable future move in the underlying — it has no current exercise value. An ITM option already contains a guaranteed profit component through its intrinsic value.

Deep Out of the Money — The Risk and Appeal

Options that are far from their strike prices — deeply out of the money — have very low premiums because the probability of the underlying price reaching the strike before expiration is low. A call with a strike price fifty percent above the current stock price costs far less than a call with a strike price five percent above the current price, because the underlying must move much further to put the deep OTM call in the money.

This low cost is simultaneously the primary attraction and the primary risk of deep OTM options for speculators. The low premium means the total dollar risk is capped at a small amount — the buyer cannot lose more than the premium paid. But the probability of the option expiring worthless is high — deep OTM options expire without value in the majority of cases.

The potential return if the underlying does reach and exceed the strike is very large in percentage terms relative to the small premium paid, but the probability-weighted expected value is typically negative for buyers of deeply out-of-the-money options.

OTM at Expiration — The Zero Value Rule

At expiration, an out-of-the-money option is worth exactly zero and expires worthless. This is absolute — there is no time value remaining at expiration, and with no intrinsic value either, the option has no value and ceases to exist.

For option buyers, an OTM option at expiration represents a total loss of the premium paid — one hundred percent of the investment in that specific option is lost. This is the maximum loss for any option buyer — limited to the premium — but it is nevertheless a complete loss of the invested amount when the option expires OTM.

For option writers — sellers — an OTM option at expiration is the best possible outcome. The option expires worthless, the writer retains the entire premium collected with no further obligation, and no assignment occurs. The writer has no obligation to perform because the holder has no right worth exercising when the option is out of the money at expiration. The writer's maximum gain from any short option position is the premium received, and expiration OTM is the scenario that delivers that maximum gain.

The OCC Exercise-by-Exception Threshold

The OCC's exercise-by-exception procedure establishes a precise threshold that defines when automatic exercise occurs at expiration. An option is automatically exercised if it is in the money by at least one cent per share at expiration. This means an option that is exactly at the money — intrinsic value of exactly zero — is not automatically exercised. An option that is OTM by any amount — even one cent — is not automatically exercised and expires worthless.

The one-cent boundary is the precise dividing line between automatic exercise and expiration without value. A call with a fifty dollar strike when the stock closes at fifty dollars is at the money — not automatically exercised. A call with a fifty dollar strike when the stock closes at fifty dollars and one cent is in the money by one cent and is automatically exercised unless the holder provides contrary instructions. An option closing at forty-nine dollars and ninety-nine cents is out of the money by one cent and expires worthless with no action required.

Examination Drill — Four Scenarios

The Series 7 and SIE examinations test OTM identification through rapid scenario analysis. Candidates must work through calls and puts with different strike prices and market prices and identify which are OTM.

GHI stock trades at forty-eight dollars. Which of the following are out of the money? A GHI forty-five call — in the money, market above strike. A GHI fifty call — out of the money, market below strike. A GHI forty-five put — out of the money, market above strike. A GHI fifty put — in the money, market below strike.

JKL stock trades at sixty-three dollars. Which are out of the money? A JKL sixty call — in the money by three dollars. A JKL sixty-five call — out of the money by two dollars. A JKL sixty put — out of the money by three dollars. A JKL sixty-five put — in the money by two dollars.

The pattern is consistent: calls are OTM when the market price is below the strike. Puts are OTM when the market price is above the strike. The mnemonic — call up, put down — applied consistently confirms which state each option is in without requiring derivation of the underlying logic each time.

OTM, ATM, and ITM — Premium Levels Compared

Understanding how the three moneyness states affect premium levels is also directly examination-relevant.

In-the-money options carry the highest premiums of the three states, all else equal, because they contain intrinsic value in addition to time value. A call thirty dollars in the money carries substantially more premium than an at-the-money call at the same expiration, because the former already includes thirty dollars of guaranteed exercise value.

At-the-money options typically carry the highest time value of the three states, though their total premium is lower than in-the-money options of the same expiration because they contain no intrinsic value. ATM options have maximum time value because they sit at the inflection point where relatively small price moves in either direction determine whether the option expires with or without value — the probability of moving into the money is approximately fifty percent, creating the highest sensitivity to time remaining and volatility.

Out-of-the-money options carry the lowest premiums of the three states, consisting entirely of time value that declines as expiration approaches and as the underlying price remains distant from the strike. Deeply OTM options may trade for pennies as expiration nears and the probability of reaching the strike becomes negligible.

Examination Relevance and Key Takeaways

Out of the money is tested on the SIE and Series 7 examinations in the context of options moneyness, intrinsic value versus time value, premium levels, the OCC exercise-by-exception threshold, and the basic mechanics of call and put options.

The key points to retain are these.

Out of the money means the option has zero intrinsic value — exercising it immediately would produce a loss relative to transacting directly in the market. A call is OTM when the underlying market price is below the strike price — the holder would pay more than the market offers by exercising. A put is OTM when the underlying market price is above the strike price — the holder would receive less than the market offers by exercising. The mnemonic is call up — calls are in the money when the market goes up above the strike and out of the money when the market is down below the strike — and put down — puts are in the money when the market goes down below the strike and out of the money when the market is up above the strike.

An OTM option's premium consists entirely of time value — extrinsic value — with zero intrinsic value. Higher implied volatility and more time remaining to expiration both increase OTM time value by increasing the probability the underlying reaches the strike before expiration. At expiration an OTM option is worth exactly zero and expires worthless — representing a total loss of the premium for the buyer and the maximum gain for the writer who retains the entire premium.

The OCC exercise-by-exception threshold requires in-the-money status of at least one cent per share for automatic exercise — options exactly at the money and all OTM options expire without automatic exercise. OTM options carry the lowest premiums of the three moneyness states while ITM options carry the highest due to their intrinsic value component.