Welcome to the Dopex Essentials series that helps everyone get acquainted with the basics of options trading. In this article, we will focus on three key terms you need to know when trading options.
Here is the complete list of parts of this Series:
In addition to this series, people can also refer to the following articles to better understand Option Trading and Dopex!
- Huge Growth Potential of Options in DeFi
- Exchange Between Weakhand & Dopex – Leading Options Platform on DeFi (Vietnamese)
- What is Dopex (DPX)? Overview of Dopex Cryptocurrency
- Series 9: Real Builder | Dopex – Growing Amid Difficult Insects
In the money – ITM
“In the money” (ITM) is a term that refers to the intrinsic value of an options contract. Used to refer to one option where the correlation between the strike price and the current market value of the underlying asset is helpful gives buyers options.
ITM in Call options
A call option achieves ITM status if the current market value of the underlying asset higher exercise price. The option buyer can exercise his right under the contract and buy the underlying asset at a price below its current market value. And this is stated as “Yes call option intrinsic value”.
If the strike price of a call option is $6 and the underlying is currently trading at $7, the option is ITM. The higher the price above $6, the more ITM options and the greater its intrinsic value.
Another example:
Call options have a price A strike of $25 would be ITM if the underlying asset was trading at $30. The difference between the exercise price and the market price is the option fee (premium).
An investor who holds the said option until maturity and it remains ITM can exercise that option and earn the difference between the strike price and the market value. Whether the transaction is profitable or not depends on the total cost of buying the contract and any fees paid to the exchange.
ITM in Put option
A put option achieves ITM status, which means it is in-the-money if the current market value of the underlying asset lower exercise price. The option buyer can exercise his right under the contract and sell the underlying asset for more than its current market value. And this is stated as “Put option yes intrinsic value“.
For example:
If the strike price of a put option is $6 and the underlying is currently trading at $3, then the option is ITM. The lower the price below $6, the more ITM options and the greater its intrinsic value.
In short:
- An ITM call option means that the option buyer can buy the asset below the current market price.
- An ITM put option means that the option buyer can sell the asset above the current market price.
- An option being ITM does not mean the trader is making a profit from the trade.
- A call option that reaches ITM when the contract expires is profitable if the market price is higher than the strike price
- A put option that reaches ITM when the contract expires is potentially profitable if the market price is lower than the strike price.
When you choose ITM but still lose money
Suppose Mr. Witherblock holds a Bitcoin call option with a strike price of $30. Bitcoin currently trades at $33 USD at expiration (ITM contract). The call option allows Mr. Witherblock to sell Bitcoin for $33, giving him a $3 premium per Bitcoin. Each options contract represents 100 Bitcoins, so the intrinsic value is $3 x 100 = $300.
Suppose Mr. Witherblock paid a call premium of $3.50. In this case he will not profit from the transaction. Why? Well, Witherblock would have to pay $350 ($3.50 x 100 = $350) in premium while only making $300 on the difference between the strike price and the market price. In other words, Mr. Witherblock would lose $50 on the transaction. However, the option is still considered ITM because at expiration, the option is worth $3 even though Mr. Witherblock did not make any profit.
Now, let’s say the price of Bitcoin drops from $33 to $29, that means the $30 strike price is no longer ITM but is $1 OTM.
It should be noted that although the exercise price is fixed, the price of the underlying asset will fluctuate, affecting the intrinsic value of the option. ITM options can convert to ATM or even OTM before the expiration date.
Out of the Money – OTM
“Out of the money” (TTM) is a term that refers to the intrinsic value of an options contract. Used to refer to one option for which the correlation between the exercise price and the current market value of the underlying asset is disadvantage gives buyers options.
OTM in Call options
OTM call option if the current market value of the underlying asset is less than the strike price. At this point, if the option buyer exercises the right to buy, they must spend more money than the market value of the asset.
If the strike price of a call option is $6 and the underlying asset is currently trading at $5, then the option is OTM. The lower the price below $6, the more OTM options.
OTM in Put option
OTM put option if the current market value of the underlying asset is higher than the strike price. If the buyer of a put option exercises the right to sell the underlying asset, they will receive less money than the market value of that asset.
If the strike price of a put option is $5 and the underlying asset is currently trading at $6, then the option is OTM. Market price of the underlying asset The higher it is above $5, the more OTM options it has.
Because OTM call and put options cannot be exercised for profit, their intrinsic value is zero.
For example:
Bella buys an ETH call option with a strike price of 20 USD. This option expires in 5 months and has a premium of $0.50. Meaning she has the right to buy ETH at $20 on the expiration date. ETH is currently trading at $18.50.
This option is OTM from the start, because if Bella exercises this option she will have to buy ETH at $20 when she could buy it at the market price of $18.50. Even though this option is OTM, it is still not worthless because (unexpired) it still has the potential to be profitable if converted to ITM.
If ETH is trading at $22 at expiration then ITM options. This option gives Bella the right to buy ETH at $20, while the current market price is $22 USD. The difference between the strike price and the current market price is $2 (this is the intrinsic value of the contract). In this case, Bella earns a net profit of $1.50 because paid the $0.50 premium, the overall option now has an intrinsic value of $2.
But what if ETH only reaches $20.25 when the option expires? In this case, the option is still ITM, but Bella has a net loss. She paid a $0.50 premium, but the option is now only worth $0.25, resulting in a loss of $0.25.
At the Money – ATM
“Out of the money” (TTM) is a term that refers to the intrinsic value of an options contract. Used to refer to one option whose exercise price is equal to the current market value of the underlying asset.
That is, if the strike price of a call or put option is $60 and the underlying asset is currently trading at $60, then the option is ATM. ATM buy and sell options are not exercised because they have not yet made a profit, so their intrinsic value is zero.
Conclude
- An option is ATM when the strike price and the market price of the underlying asset have the same value
- An option is OTM if the strike price and market price correlation is not favorable to the option buyer
- An OTM call option means that the call option has an exercise price higher than the market price of the underlying asset. Meanwhile, the OTM put option will have an exercise price lower than the market price.
- An OTM option means that the option is not yet profitable because the price of the underlying asset has not moved enough to make the option profitable. Therefore, OTM options typically have lower premiums than ITM options.
- The value of the premium paid for an option depends largely on whether the option is ITM, ATM or OTM.
- Many factors can affect the premium of an option, including market volatility and the time until the contract expires. The higher the volatility and the longer the time to expiration, the more likely it is that the option can reach a higher ITM. Synonymous with Insurance premiums are usually higher.
Introducing Dopex
Dopex is a decentralized options protocol that aims to maximize liquidity, minimize losses for option writers, and maximize profits for passive options traders.
This article is done based on the combination of Dopex & Weakhand
