An option has three types of moneyness.

· In the money

· Out of the money and

· At the money

In-the-money is the term used to mean that if the option were to be exercised by the holder, it would result in a profit.

In the case of a call option, the strike price must be less than the spot price for it to be in-the-money. In the case of a put option, the strike price must be greater than the spot price for it to be in-the-money.

The term out-of-the-money denotes that if the option were to be exercised by the holder, it would result in a loss. In the case of a call option, the strike price will be higher than the spot price for it to be out-of-the-money. In the case of a put option, the strike price will be lower than the spot price for it to out-of-the-money.

The term at-the-money denotes that the option strike price and the spot price are the same.

In options trading, the profits made by one trader would have resulted in equal losses to another trader. At the time of the expiry of the contracts, the total wealth among the traders remains the same.

It means that because call and put options take opposite positions, an in-the-money option contract for a call option holder will be out-of-the-money to a put option holder. The status of the option writers will be exactly opposite to that of the call and put option holders.

An in-the-money option for an option holder will be out-of-the-money to an options writer. Also, an out-of-the-money option for an option holder will be in-the-money to an options writer.

The option contract will be at-the-money for both the holder and the writer.

Why is moneyness important.

A correct understanding of the moneyness is needed to choose the right option.

It is a term that is the most commonly used, and all strategies in options trading based on moneyness.

Moneyness has a direct impact on decisions in options trading.

Moneyness tells us if the options contract has intrinsic value or not.

If the options were to be exercised the money one would receive is the intrinsic value.

Only those options contracts that are in-the-money has any intrinsic value.

Let us say that the strike price of a call option is Rs.200, and the stock is trading at Rs.250. The options trader can exercise the options to buy the stock at Rs.200 and sell the same at the market price of Rs.250. The trader makes a profit of Rs.50. Here the intrinsic value of the options contract is Rs.50.

There is no intrinsic value for out-of-the-money options because by exercising the options, no money is made.

In brief

· An in-the-money option is in profits and therefore has intrinsic value.

· An out-of-the-money option is in loss and therefore has no value.

· An at-the-money option is not in profit or loss and also has no value.

· Holders of Call and put options are inversely related to writers of call and put options. An in-the-money situation for one will be an out-of-the-money situation for the other.

· Depending on the change in the price of stocks, the moneyness of the option contract changes.

· Deep-in-the-money option is another term for an option contract that is greatly in-the-money, and another term for the greatly out-of-the-money options is deep-out-of-the-money.

· As cost is involved, no option contract will be exactly at-the-money position at the time of expiry.