3. Option Moneyness: ITM, ATM, OTM

Moneyness describes whether an option would be profitable if exercised right now. It tells us how the strike price compares to the current market price. The terms are:

• ITM (In-the-Money): The option currently has intrinsic value. For calls, ITM means strike price < current price (you can buy cheaper than market via the option). For puts, ITM means strike price > current price (you can sell higher than market via the option).

• ATM (At-the-Money): The option’s strike is roughly equal to the current market price. Neither a clear profit nor loss if exercised now. Practically, whichever strike is closest to the current underlying price is deemed ATM.

• OTM (Out-of-the-Money): The option currently has no intrinsic value. For calls, OTM means strike > current price (why buy via option at a higher-than-market price?). For puts, OTM means strike < current price (why sell via option at a lower-than-market price?). These options are all extrinsic value (just the possibility of becoming ITM later).

Why Moneyness Matters:

It influences the option’s premium and behavior:

• ITM options are expensive (they've got intrinsic value plus some time value). They behave more like the underlying – a deep ITM call, for example, will move almost rupee-for-rupee with the index because it’s almost a substitute for holding the index.

• OTM options are cheap (all time value) but risky – they can expire worthless if the move doesn’t come. They have lower probability of expiring in profit, hence low price.

• ATM options have the highest time value (uncertainty is max here) and are very sensitive to movements (this is where the option’s Gamma is usually highest – more on Greeks soon).

Real-World Example (BANKNIFTY):

Suppose BANKNIFTY index is at 40,000.

• An ITM Call might be the 39,000 strike. This is 1,000 points in-the-money (strike well below current price). The premium might be, say, ₹1,050. That includes ₹1,000 intrinsic (40,000–39,000) plus ₹50 extrinsic.

• An ATM Call is around 40,000 strike. Premium might be ₹300 (mostly all extrinsic since intrinsic is ~0).

• An OTM Call could be 41,000 strike. Premium might be just ₹100 (all extrinsic, as it’s 1,000 points out-of-the-money).

For puts with BANKNIFTY at 40k:

• ITM Put: 41,000 strike put (since strike > spot). If trading at, say, ₹1,020 premium, that’s ~₹1,000 intrinsic (41k–40k) + ₹20 extrinsic.

• ATM Put: 40,000 strike ~ ₹290 premium.

• OTM Put: 39,000 strike put maybe ₹80 premium (all extrinsic, needs a big drop to gain value).

You can notice ITM options have much higher premiums than OTM. Also, exchanges often highlight ITM strikes for easy identification (for example, NSE’s option chain shows ITM options with a colored background ).

Price Impact of Moneyness:

Being ITM or OTM also affects how the option reacts to the underlying price changes. ITM options (especially deep ITM) have high Delta (near 1 for calls, -1 for puts), meaning they move nearly point-for-point with the underlying. OTM options have low Delta (far OTM might have delta 0.1 or 0.2), so a small move in the underlying may only slightly move the option premium. ATM options have delta ~0.5, giving a balanced response.

Choosing Strikes – a quick thought:

A trader might choose an ITM option for a more conservative play (higher probability of some profit, but also more capital outlay), or an OTM option for a high-risk high-reward punt (cheap, but needs a significant move to pay off). For instance, if you strongly believe BankNifty will rally, you might buy an OTM call for cheap and hope it goes ITM. If you want a safer bet, you’d buy an ITM call, which costs more but will respond more reliably to the rise. There’s no free lunch – ITM has higher chance but costs more; OTM is cheap but low odds. Make sure you understand this trade-off.

Now that we know about moneyness, let’s discuss what happens as these options approach their expiry and how they are settled in Indian markets.