How it unfolds, step by step
The setup
Three calls on Index X, struck at 19,800, 20,000 and 20,200, with the index opening the fortnight at 19,880. The 19,800 call is in the money. The 20,000 call is close to at the money. The 20,200 call is out of the money by 320 points.
What happens next
The index climbs steadily to 20,120 and then falls back to 19,940. Each strike changes its label as the line crosses it. The 20,000 call spends the middle of the period in the money and ends out of it. The 20,200 strike is never crossed at all.
What it means — and does not
The same underlying, the same fortnight, three different experiences. The in-the-money call keeps a floor under its premium the whole way, because its intrinsic value never goes to zero. The out-of-the-money call has no floor. Every rupee of its premium is time value. If the level never crosses 20,200, that premium expires at nothing. Moneyness is the label for that difference, and it is the reason a cheap option is cheap.
- Index level
- Strike 19,800 · 19,800
- Strike 20,000 · 20,000
- Strike 20,200 · 20,200
The index crosses one strike and never reaches another, so the same three calls change label without any of them changing.
Show the underlying data
| Day | Index level |
|---|---|
| 1 | 19,880 |
| 2 | 19,910 |
| 3 | 19,945 |
| 4 | 19,990 |
| 5 | 20,035 |
| 6 | 20,070 |
| 7 | 20,105 |
| 8 | 20,120 |
| 9 | 20,085 |
| 10 | 20,040 |
| 11 | 20,010 |
| 12 | 19,985 |
| 13 | 19,960 |
| 14 | 19,950 |
| 15 | 19,940 |
What this does not establish
The reading fails at the crossing. A strike labelled in the money is only in the money while the level stays on its side of that strike. On this chart the 20,000 call is in the money on day 6 and out of it on day 15, without anything else changing. That crossing is the level the whole label depends on. Treating a moneyness label as a lasting property of an option, rather than a description of this instant, is the mistake the chart is drawn to show.
Things to check
4Where does the current level sit against the strike: above, below, or on it?
Is the option a call or a put? Every label reverses between them.
How much of this premium is intrinsic, and how much is only time value?
Remember: the labels describe the present arrangement, not a forecast.
Common mistakes
2Treating out of the money as 'cheap and therefore better value'. It is cheap because it is worth nothing unless the level crosses the strike.
Carrying the call definitions over to puts, where in and out of the money are the other way round.
A call is described as out of the money. What does that label actually say about it?
- The underlying is below its strike right now
- It is unlikely to be worth anything
- It is the cheaper and therefore better-value choice
Show the answer
A. The underlying is below its strike right now
Moneyness is a statement about where the level sits against the strike at this instant, and nothing else. It is not a probability, and it is not a rating: the same option changes label the moment the level crosses, with nothing about the contract having changed.
Frequently asked
3Is an in-the-money option better than an out-of-the-money one?
Neither is better. They are different arrangements. An in-the-money option costs more, and carries intrinsic value that only disappears if the level crosses the strike. An out-of-the-money option costs little, and is worth nothing at expiry unless the level does cross.
What does at the money mean exactly?
That the strike and the current level are the same, or as close as the available strikes allow. Exchanges list strikes on a fixed interval, so the at-the-money strike is the listed one nearest the level rather than an exact match.
Do these labels work the same way for puts?
They reverse. A put is in the money when the level is BELOW its strike, because that is when exercising it would be worth something.