What is the Moneyness of an Option? Definition, Formula, and Example
Moneyness describes the relationship between an option's strike price and the current market price of the underlying asset, determining whether the option has intrinsic value.
What is the Moneyness of an Option?
Moneyness describes the relationship between an option's strike price and the current market price of the underlying asset, determining whether the option possesses intrinsic value. Options are categorized as In-The-Money (ITM), At-The-Money (ATM), or Out-Of-The-Money (OTM) based on this metric. Moneyness is a foundational concept in options pricing, as it directly dictates the intrinsic value of the contract and heavily influences its extrinsic value, time decay, and sensitivity to underlying price movements.
How it is Calculated
Moneyness is calculated differently for calls and puts:
Call Options:
- In-The-Money (ITM): Underlying Price > Strike Price. Intrinsic Value = Underlying Price - Strike Price.
- At-The-Money (ATM): Underlying Price = Strike Price. Intrinsic Value = 0.
- Out-Of-The-Money (OTM): Underlying Price < Strike Price. Intrinsic Value = 0.
Put Options:
- In-The-Money (ITM): Underlying Price < Strike Price. Intrinsic Value = Strike Price - Underlying Price.
- At-The-Money (ATM): Underlying Price = Strike Price. Intrinsic Value = 0.
- Out-Of-The-Money (OTM): Underlying Price > Strike Price. Intrinsic Value = 0.
Quantitative traders also use "Moneyness" as a continuous variable, expressed as the ratio of the underlying spot price to the strike price (S/K), or the logarithm of this ratio. In quantitative finance, an option is considered at-the-money when the logarithmic ratio is zero.
Worked Example
Assume AAPL is trading at $190. A trader evaluates the following options:
- 165 Call Option: The strike price ($165) is less than the underlying price ($190). This call is $25 In-The-Money (ITM). The intrinsic value is $25. The option premium will be at least $25.
- 190 Call Option: The strike price ($190) equals the underlying price ($190). This call is exactly At-The-Money (ATM). The intrinsic value is $0, and the premium consists entirely of extrinsic value.
- 210 Call Option: The strike price ($210) is greater than the underlying price ($190). This call is $20 Out-Of-The-Money (OTM). The intrinsic value is $0, and the premium is derived purely from time and volatility value.
- 210 Put Option: The strike price ($210) is greater than the underlying price ($190). This put is $20 In-The-Money (ITM). The intrinsic value is $20.
When Traders Use It
Traders use moneyness to structure trades based on directional conviction and risk tolerance. ITM options have higher deltas, meaning they move more closely with the underlying stock, and require less extrinsic value premium to break even. Traders seeking high leverage with low capital outlay favor OTM options, accepting that the underlying must move significantly to overcome the lack of intrinsic value. Market makers and quantitative traders rely on moneyness to standardize volatility smiles and skew charts across different expirations and strikes.
Limitations and Common Misconceptions
A common misconception is that ITM options are always profitable. While ITM options possess intrinsic value, the trader still requires the underlying price to move favorably to overcome the premium paid for the extrinsic value. Conversely, novice traders often assume OTM options are "cheap" or "free." In reality, OTM options have a high probability of expiring worthless, and their premiums are highly sensitive to time decay (theta) and implied volatility drops. Moneyness alone does not determine profitability; the speed of the underlying price movement relative to time decay is the ultimate deciding factor.