What is Out of the Money (OTM)? A Simple Guide
An option is out of the money (OTM) when it has no intrinsic value. A call is OTM when the price is below the strike; a put is OTM when the price is above the strike. OTM options are made entirely of time value and are the cheapest to buy.
Out of the money options are the cheapest and most tempting, but also the riskiest for buyers. They are pure bets on a move that has not happened yet.
Many beginners are drawn to cheap OTM options without seeing the odds. This explainer keeps the language simple and the examples Indian. You can study them in the option chain on Stockk.
Key Takeaways
- An OTM option has no intrinsic value.
- A call is OTM when price is below the strike.
- OTM options are the cheapest to buy.
- They offer large leverage on a strong move.
- Most OTM options expire worthless.
Why do traders buy OTM options?
Let us say NIFTY trades at 22,600. A 22,800 call is OTM, because the right to buy at 22,800 is worthless while the index sits at 22,600. Its low premium is purely a bet that the index will rise past the strike before expiry.
OTM options are cheap, so they offer large leverage if the underlying makes a strong move in the expected direction. A small premium can multiply quickly if the option moves into the money.
What are the risks of OTM options?
- No intrinsic value: they expire worthless unless the price moves past the strike
- Harsh decay: they suffer the fastest time decay relative to their price
- Low odds: most OTM options expire worthless
The low cost masks a low probability of profit, which is the main trap for new traders.
The low-probability bet trap
A cheap OTM option has a small cost and a large possible payoff, so it can look tempting. Occasionally one pays off strongly, which traders tend to remember. But most expire worthless, and the losses quietly add up over many trades. The mistake beginners make is buying many cheap OTM options and counting on the rare winner, when the steady stream of small losses usually outweighs the occasional large gain.
OTM at a glance
| Feature | OTM option |
|---|---|
| Intrinsic value | Zero |
| Premium | Lowest |
| Leverage | High |
| Chance of profit | Low |
Want to apply this? Trade futures and options on Stockk, open a free demat account, and keep exploring the Knowledge Center for deeper dives.
Futures and Options are leveraged products and carry a high risk of loss that can be more than the money you put in. This article is only for learning and is not a recommendation to trade in derivatives.
Frequently Asked Questions
What makes a call option OTM?
A call is OTM when the spot price is below its strike. It has no intrinsic value, so its entire premium is time value.
Why are OTM options cheap?
They have no intrinsic value and a lower chance of paying off, so the market prices them low. The cost reflects the small chance of profit.
Do most OTM options expire worthless?
A large share of OTM options do expire worthless, since the underlying must move past the strike to pay off. Sellers often profit from this tendency.
Are OTM options good for beginners?
Their low cost is appealing, but the high failure rate and rapid decay make them risky for newcomers. Understanding the odds is essential.
Why would someone sell OTM options?
Sellers collect premium betting the option stays OTM and expires worthless, since the odds favour that outcome.
Investments in securities market are subject to market risks. This article is for educational purposes only and does not constitute investment advice.
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