Know moneyness in Options for better strike selection

Strike Price of an Option is the pre-determined price at which the underlying asset can be bought or sold

Shubham Agarwal

Options have a unique quality of letting us take advantage of a directional move by paying a very small amount of premium. Buying both Call and Put options can make us eligible for a much bigger profit than what we invest

However, as we all know that the same expiry and same symbol have multiple Call and Put options. These options belong to the same symbol and has the same expiry but they have different strike price or exercise price. To refresh our memories Strike Price of an Option is the pre-determined price at which the underlying asset can be bought or sold, by the option buyer (depending on whether it is a call or put option) upon expiry of the option.

More importantly, the price difference between the current market price of the underlying and the strike price determines the moneyness of the option and also the option premium.

Let us understand 3 Different kinds of Moneyness first to understand how they can help in better strike selection.

1. In the Money

2. At The Money

3. Out of the Money

Second first, At The Money strikes. At The Money strikes are those strikes that are closest to the current market price.

Other than that, the word moneyness explains most of it. If the Option expires right now and makes money it is called In the Money, or else Out of the Money.

So, if we have a Call Option (Option to Buy) with a strike price lower than current market price that is expired right now, we will be able to Buy Cheaper than the current market price and would be able to profit from it. So, All Call Options with Strike Price Below current Market Price are In The Money Strikes.

Similarly, let us look at some Strike Prices below the current market price for Put Options (Option to Sell). If that strike Put option expires today, we will be selling lower than the current market price. Selling anything lower than its market value does not profit, so all Put Option Strikes lower than the current market price are Out of the Money strikes.

Let us look at it with an example. If the Stock Price is 101. With available strikes being 95,97.5,100,102.5,105.

The utility of knowing the Moneyness is very simple. The absolute Profit-making capability of In the Money Option Strike is Higher than At The Money Strike. Similarly At The Money Strike can make us more money than Out of The Money Option with the same move.

At the same time Losses, if we are wrong would be bigger in In the Money Strike than At The Money Strike than Out of The Money Strike Options. Simplest way to use this characteristic of Moneyness is by making sure that our Moneyness reflects our Confidence in the trade.

More Confident Trade >> Buy In The Money Strike Option

Moderately Confident Trade >> Buy At The Money Strike Option

Less Confident Trade >> Buy Out of The Money Strike Option