Learn ATM, ITM, and OTM in Options Trading

The speed at which the ship sails (assume its equivalent to the option premium) depends on various forces such as wind speed, sea water density, sea pressure, and the power of the ship. Some forces tend to increase the speed of the ship, while some tend to decrease the speed of the ship. The ship battles these forces and finally arrives at an optimal sailing speed. XYZ becomes worthless, but you have to buy 100 shares at the strike price anyway. Because you may have to borrow to raise the cash to buy the shares, your loss might be higher than the value of the shares at the strike price. Therefore, the maximum loss is the value of the shares at the strike price.

1. Options contracts exist on many financial products, including bonds and commodities.
2. Let’s consider Put options, which you propose to define (Q2, Q4) as the counterparty “calling” the option holder to buy the security from the option holder.
3. It is determined by how far the market price exceeds the option strike price and how many options the investor holds.
4. If the price of ABC eventually increases to Rs. 60 in the following month, the buyer exercising this call option can buy 100 shares at Rs. 55 and sell those immediately at Rs. 60 in the market.

For put options, that happens when the stock’s price is below the option’s strike price. For call options, that happens when the stock’s price is above the strike price of the option. An investor holding a call option that’s expiring in the money can exercise it and earn the difference between the strike price and market price. Whether the trade is profitable or not depends on the investor’s total transaction expense. The phrase in the money (ITM) refers to an option that possesses intrinsic value.

She (the seller) is contractually obligated to the call buyer/owner. Only the call option buyer/owner has a choice of whether to exercise his option or to allow it to expire. In the latter case (expiry), she (the seller) gets to keep his (the buyer/owner’s) money. Call options are considered more profitable because they have unlimited gain potential. This is primarily because there is no upper limit on the price of a stock. Whereas put options’ profit potential is limited because a stock’s price won’t drop below zero.

X, being the holder of a call option, retains his/her right to purchase 100 shares of ABC at Rs. 55 till the expiration date. Buy Call Option Example – Assume that Gammon India stocks are at Rs. 100 for each share. B, an investor, holds 100 such shares and seeks to generate income beyond the dividend. The stocks are not expected to increase beyond Rs. 120 in the next month. B assesses call options to find that a call trading of Rs. 120 exists at 40p each contract.

Call Options

This is because the chances of a price move in the underlying stock diminish as we draw closer to expiry. If you buy a one-month option that is out of the money, and the stock doesn’t move, the option becomes less valuable with each passing day. But there’s a way to collect premium up front, give yourself a bearish or bullish bias, and limit your risk. It’s called a vertical spread, and if you’re ready to take your options knowledge to the next level, it’s a great place to start.

Figure 2 below shows the payoff for a hypothetical 3-month RBC put option, with an option premium of $10 and a strike price of $100. The buyer’s potential loss (blue line) is limited to the cost of the put option contract ($10). The put option writer, or seller, meaning of call and put option is in-the-money as long as the price of the stock remains above $90. The term “uncovered” simply means you’re selling a call option contract that’s not covered by a position in the underlying security.

When to Use Call Options?

1. Whether you want to use a call option or a put option depends on which side of the transaction you’re on and your predictions about future price movement.
2. Calls and puts should be understood from the perspective of the option writer, along with the corresponding prepositions “away” and “to.”
3. The choice between ITM, ATM, or OTM options depends on your strategy and market outlook.
4. Investors buy puts when they believe the price of the underlying asset will decrease and sell puts if they believe it will increase.
5. Covered calls writers can buy back the options when they are close to in the money.
6. In our home example, the deposit might be $20,000 that the buyer pays the developer.

However, if the stock moves significantly in either direction, Jane could lose money when the buyer exercises the contract. When you buy a call option, you’re buying the right to purchase shares at the strike price described in the contract. You’re hoping that the stock’s price will rise above the strike price of the option. If it does, you can buy shares at the strike price, which is lower than the current market price, and sell them immediately for a profit. An in-the-money put option means that the strike price is above the market price of the underlying security.

Speculation – Buy calls or sell puts

Puts can also be uncovered, if you don’t have enough cash in your brokerage account to buy the security at the option’s strike price, should the option buyer choose to exercise it. That’s when you don’t already own the security (or enough of the security) to sell the buyer if he or she chooses to exercise the call. An investor should sell a call option if there is a reason to believe that the price of assets may plummet. The premium amount can still be recovered if the asset’s price drops below the strike price. Buying a call option can be more lucrative than purchasing security because the former provides more leverage to the holder. In the case of price rise, a holder stands to make substantial gains as opposed to only selling the security.

However, option writing a put obligates the investor to buy Tata Motors shares at Rs.300 if the market price drops below that level. Keep in mind that buying options is less risky than selling them. The option sellers (call or put) are also called the option writers. The buyers and sellers have the exact opposite P&L experience.

Call – think of an open auction when bidders call out their prices for an auctioned item. So with a call option you’ve got a privilege to call the strike price, effectively having a right to buy the underlying asset. The naked short put is also a high-risk position, but technically slightly less risky than a naked short call.

Why Trade Options?

Therefore, the greater the volatility, the greater the price of the option. Options trading and volatility are intrinsically linked to each other in this way. The owner is always the buyer.The owner is never the seller. The key differences between the call option and the put option are detailed in the comprehensive table below, which compares the two types of options across several dimensions.

For example, let’s assume stock ABC has a price per share of Rs. 50. X buys one call option of Rs. 55 for ABC as the strike price and expiration date in one month. It is anticipated that its price will increase to Rs. 55 in the following month.

Due to how deeply they are in the money, the prices of these options usually move just as the price of the underlying asset moves. Investors who purchase put options believe that the underlying asset’s price will decrease and close below the strike price by the option’s expiration date. They are bearish on the price direction of the underlying security.