Share Market Study - Moneyness ( Episode - 06)

Share Market Study  - Moneyness ( Episode - 06) 

         

 Moneyness is a term commonly used in finance and options trading to describe the relationship between the strike price of an option and the current price of the underlying asset. It helps determine the intrinsic value of an option and provides insights into its potential profitability.

In options trading, an option gives the holder the right, but not the obligation, to buy or sell the underlying asset at a predetermined price, known as the strike price, within a specified period. Moneyness categorizes options into three main categories:

1) In-the-money (ITM): An option is considered in-the-money when the strike price is favorable for the holder. For a call option (the right to buy), it is in-the-money when the current price of the underlying asset is higher than the strike price. Conversely, for a put option (the right to sell), it is in-the-money when the current price of the underlying asset is lower than the strike price. In-the-money options generally have intrinsic value, which means they would be profitable if exercised immediately.

2) At-the-money (ATM): An option is at-the-money when the strike price is approximately equal to the current price of the underlying asset. In this case, the option's intrinsic value is close to zero, and its value mainly consists of time value, which represents the potential for the underlying asset's price to move in a favorable direction before the option expires.

3) Out-of-the-money (OTM): An option is out-of-the-money when the strike price is not favorable for the holder. For a call option, it is out-of-the-money when the current price of the underlying asset is lower than the strike price. For a put option, it is out-of-the-money when the current price of the underlying asset is higher than the strike price. Out-of-the-money options do not have intrinsic value and rely solely on the possibility of the underlying asset's price moving favorably before the option expires.

Moneyness is a crucial concept for options traders as it helps them assess the potential profitability and risk associated with different options. In-the-money options tend to have higher prices due to their intrinsic value, while out-of-the-money options are generally cheaper. Traders may choose different moneyness levels based on their specific strategies, market expectations, and risk tolerance.