What is Strike Price, ITM, ATM, and OTM?

In the complex world of Options trading, it’s important to have a solid understanding of some of the terminology associated with it. One of the most critical components of options trading is the strike price. But what exactly is a strike price? And what do terms like In the Money (ITM), At the Money (ATM), and Out of the Money (OTM) mean?
In this article, we’ll explore the concept of strike price and its classifications in detail to help you make informed decisions when trading options. Whether you’re a seasoned trader or just starting, understanding the strike price and its classifications is essential for success in options trading. So, let’s dive in!

Strike Price

One of the most critical components of an option contract is the strike price. Strike price refers to the price at which the underlying security can be bought or sold when exercising the option contract. The strike price is a fixed price set at the time of the option’s creation and does not change throughout the life of the option contract.
In options trading, the strike price is classified into three categories: In the Money (ITM), At the Money (ATM), and Out of the Money (OTM).

In the Money (ITM)

An option is said to be in the money when the underlying asset’s price is trading above the strike price for a call option or below the strike price for a put option. In other words, an ITM option has intrinsic value because the option can be exercised, and the trader can buy or sell the underlying asset at a favorable price.
ITM doesn’t necessarily mean the trader will make money. To make a profit, the trader needs the option’s in-the-money value to increase so that it does more than cover the cost of the option’s premium.

At the Money (ATM)

An ATM option is one where the strike price is the same as the current market price of the underlying asset. In this case, the option has both intrinsic value and time value, but the intrinsic value is zero. The trader needs the price of the underlying asset to move in the desired direction before the option expires to make a profit. If the price stays the same, the trader will lose the premium paid for the option. To make a profit with an ATM option, the trader needs the price of the underlying asset to move enough in the desired direction to overcome the time value of the option and earn a profit that exceeds the premium paid for the option.

Out of the Money (OTM)

An OTM option is one where the current market price of the underlying asset is lower than the option’s strike price (for call options) or higher than the strike price (for put options). In other words, the option has no intrinsic value, and the trader only pays for the option’s time value. If the underlying asset’s price does not move in the right direction before the option expires, the trader will lose the premium paid for the option. Therefore, to make a profit with an OTM option, the trader needs the underlying asset’s price to move significantly in the desired direction before the option expires so that the option becomes in the money and the profit exceeds the premium paid for the option.

Final Thoughts

Understanding the concept of strike price and the classifications of ITM, ATM, and OTM is essential for options trading. It helps traders assess the potential profit or loss of an option contract before they buy or sell it.
It’s also important to note that the premium of an option contract is affected by its strike price and its classification of ITM, ATM, or OTM. An ITM option has a higher premium because it has intrinsic value, while an OTM option has a lower premium because it has no intrinsic value. An ATM option’s premium is typically in between the premiums of ITM and OTM options.
Traders can use the strike price and classification of an option to create various trading strategies. For example, a trader who expects the underlying asset’s price to increase can buy a call option with an ITM or ATM strike price to maximize potential profit. On the other hand, a trader who expects the underlying asset’s price to decrease can buy a put option with an ITM or ATM strike price to profit from the price drop.
In summary, the strike price is a fundamental concept in options trading that determines the price at which the underlying asset can be bought or sold when exercising the option contract. It’s important to understand the classifications of ITM, ATM, and OTM to assess the potential profit or loss of an option contract. The strike price and its classifications can also be used to create various trading strategies. With a solid understanding of the strike price and its classifications, traders can make informed decisions and increase their chances of success in options trading. So, keep these concepts in mind, and may your trading endeavors be profitable and fulfilling!