Now don’t go and try to look up that term Moneyness in the dictionary you won’t find it there. This is a term you might hear when people are talking about options. The next three terms I am going to give you the technical definitions first and then I am going to give you examples and ask some simple questions to help you remember what people are talking about when they use those terms.
The three phrases often used when describing an options moneyness are; in the money, out of the money, and at the money. A call option that you own is said to be in the money when the price of the underlying security costs more than the strike price you have locked in. The reason it is in the money is because with a call option you have the right to purchase an underlying security for a lower price than what the stock is selling for in the market. There is an immediate value to owning this option. Is that a good or bad thing for you? I would think it was a good thing to be able to purchase something cheaper than anyone else could purchase it! So because it has value it is said to be in the money.
In the following example ask yourself the simple question is there any benefit to me in owning this option right now? Right now on the market xyz stock is selling for $50.35 and you have the right to buy it for $45. Ask yourself this, would you rather pay $45 or $50.35 for xyz stock. I know if it is worth $50.35 I would much rather buy it for $45 than $50.35. So this call option is said to be in the money by $5.35, because this option is at least worth that much.
A put option is said to be in the money when the price of the underlying security is lower than the strike price. The reason it is in the money is because with a put option you are buying the right to sell an underlying security for a higher price than what the current value is on the market. If, red socks could be purchased on the open market for say $5, but you had an agreement with one customer that he would pay you $10 for your red socks, would that be a good deal for you? The obvious answer is of course, yes you just made an extra $5 more than anyone else in the market could have made.
An example in the stock market would be that XYZ is trading for $30 on the market you have the right to sell it for $40. Which price would you rather sell your stock to someone for $30 a share or $40 a share? I know if I owned something I want to get as much money for it as I can if I am going to be the one selling it. In other words your put option is worth at least $10 so it is, in the money.
Now a call option is out of the money when the underlying security is selling for less than the strike price. Why? Well if you have the right to purchase at a set price that happens to be higher than what you could get it for on the market would you want to buy it at the higher strike price? I wouldn’t want to pay more money for something that I could have purchased for less, so your option isn’t worth exercising. There is no immediate value in owning this option so it is out of the money.
Again, looking at our fake XYZ companies stock, it happens to be selling for $30 in the market today. Your Call option gives you the right to buy the underlying security for $40. Ask yourself the simple question, “would I rather purchase XYZ stock for $30 or $40?” As you can see there is no immediate benefit in having the right to purchase the stock for $40 per share if you can already purchase it on the market for $30, so this stock is said to be out of the money.
A put is out of the money when the underlying security is more expensive than your strike price. Why? Again going back to your rights spelled out in your put options contract. You have the right to sell the underlying security for less than what the security is selling for on the open market. Is that a good thing for you? Of course not, you could sell it for higher in the open market so you would not want to sell it to someone else for less money in your pocket, so the option is out of the money.
Looking again at our XYZ stock, it is selling for $50 in the market and you have the right to sell it to someone for $40. Would you want to exercise your right in the contract? No because you would rather put $50 in your pocket for the stock than $40. There is no immediate benefit to owning this put option contract so it is said to out of the money.
A call or put is at the money when the underlying security is selling at the same price as the strike price in either contract. This contract is really neither good nor bad. When you are looking at an options chain in your brokers’ platform it doesn’t usually happen that the stock price and the strike price are exactly the same. Most traders refer to the option closest to the stock price in the option chain as the at the money option.
To summarize if the option has immediate value it is in the money. If the option has no immediate value it is out of the money. And if the options strike price and price it is selling for in the market are the same or really close it is at the money.
For more beginners information on stock options you can download this free basics course.
Michael http://www.smartradenews.com We offer a free basics video course to teach you the basics of options. We have more advanced courses for a fee. So whether you are just starting out or if you want to continue your options education we have something for you. DISCLAIMER: No personal investing advice is implied or stated in any video or written presentation. The information presented is for educational purposes only and should not be construed as personal legal or investment advice.
