What are in-the-money, out-of-the-money and at-the-money options?

To order a call option, what you need to do, just call your broker and say, you would like to buy 1 GE 10.00 call option. If this call option ask price is $2.23, the premium that you need to pay is 100 multiplies 2.23, which is equal to $223. 1 GE 10.00 call option means one contract of GE call option at $10 strike price. This call option gives a right to the option buyer to buy the underlying GE shares at the exercise price of $10.00. However, the option buyer is not obligated to buy the shares. The word underlying here means the market where the option is derived. The underlying is 100 units of GE share for this example. Regardless whether the options are derived from stocks, stock indices or futures contract, they all have the above attributes in common. Private traders have many choices to put their money because currently, there are a number of option markets available.

The exercise price is also known as strike price. Every option has this price, which the call option buyer has the right to buy the underlying at this price. However, the call option buyer only exercises his or her right if the market situation gives him or her profitable earning. $10 is the exercise price in the example above. In order that the call option buyer has the right to buy 100 units GE share, which are equivalent to one contract at $10 per share at any time until the contract expiration date, he or she need to pay a premium. The premium that has been paid by the call option buyer in this example is $223 for 100 units GE share. It will not be profitable for the call option buyer to exercise his or her option if GE share price trades below $10. This is because the current price will be cheaper to be bought. If the GE stock price is higher than $10, it will be profitable for the call option buyer to exercise the option. This is because when the stock price moves higher above $10, it will be more valuable for the option. Normally, most of the options are not exercised but exit with an opposite transaction for a profit or loss before expiration date.

Each option series, which expires in different month, can be chosen by the private trader. There are more than one exercise price that can be chosen by the private trader. The price for a call option, which exercise price is higher than the current market price, is less expensive. For the call options with an exercise price higher than the current market price are known as out-of-the-money options. Contrary, call option with a lower exercise price, which is known as in-the-money-option, will be more expensive. For the call options, which exercise price is same as the current market price is known as at-the-money option.

However, the situation is reversed for put options. For put option, options with higher exercise price are more valuable. The reason is that the put option buyer has the right to sell the underlying shares, which will be more profitable if he or she sells at the higher price rather than at lower price.

Alexander Chong

Author of “Workable Option Trading Strategies”

http://www.makemoneystocks.com/

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