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Out of the money (OTM) is a term used in options trading to describe an options contract that has no intrinsic value if it is exercised today. This means it only has extrinsic value. This means if the owner exercised it, they would pay more than the current market value (in the case of a call option) or sell it for less than its current market value (in the case of a put option).
In other words, a call option is out of the money if its strike price is higher than its market or spot price. Conversely, a put option is out of the money if its strike price is lower than its spot price.
If an options contract reaches its expiration date while out of the money, it expires worthless because there is no point in exercising it. This means the owner will also lose the premium they paid for it.
However, it would be wrong to say that out of the money options are worthless. In reality, the value of an option is made up of three things: its intrinsic value, its time value (how long it remains until expiration) and the volatility of its underlying asset. The longer until the contract’s expiration and the more volatile the underlying asset, the more value an OTM option has.
Say, a call option on a highly volatile stock is OTM by $4 and expires in a month. As the underlying stock is volatile, there is a chance it could increase more than $4 within the remaining month. This would cause the option to move into the money (ITM) before its expiration. When this happens, the owner can exercise the option to buy shares of the underlying for less than the market value or resell the option for a higher premium.
Even if an OTM option does not move into the money, it can still be resold for a higher premium than what was previously paid for. This is possible if it moves closer to the money. The closer an OTM option is to being in the money, the higher its premium, which the owner can take advantage of.
The opposite of Out of the money is In the money (ITM). The latter is where options contracts have intrinsic value. For a call option, this means its strike price is lower than the current market price of the underlying asset. For a put option, this means its strike price is higher than the current market price of its underlying asset.
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