SIE PREP | FINANCIAL REGULATION COURSES
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.
