Out of the Money (OTM) Options: Meaning, Examples, Risks & Trading Guide

Out of the Money (OTM) is an important concept in options trading and one of the three basic measures of an option's moneyness, alongside In the Money (ITM) and At the Money (ATM).

Understanding OTM options is essential for anyone learning derivatives, options strategies, trading psychology, and risk management. For beginners, the key idea is simple: an OTM option currently has no intrinsic value, but it may still have value because the underlying asset could move favorably before the option expires.

Educational note: Options are complex financial instruments. This article is intended for educational purposes and should not be treated as personalized investment advice.

What Does Out of the Money (OTM) Mean?

An Out of the Money option is an options contract whose strike price is currently unfavorable compared with the market price of the underlying asset.

In simple terms, if exercising the option immediately would not produce a positive intrinsic value, the option is considered OTM.

The definition depends on whether the option is a call or a put.

OTM Call Option

A call option is OTM when:

Current Market Price < Strike Price

Example

Suppose a company's stock is trading at Rs. 100 and you own a call option with a Rs. 120 strike price.

Because you have the right to buy the stock at Rs. 120 when it is currently available in the market for Rs. 100, exercising the option immediately would not make economic sense.

Therefore, the Rs. 120 call option is Out of the Money.

OTM Put Option

A put option is OTM when:

Current Market Price > Strike Price

For example, suppose a stock is trading at Rs. 150 and you own a put option with a Rs. 120 strike price.

The put gives you the right to sell at Rs. 120, while the market price is Rs. 150. Selling at the lower strike price would not be attractive compared with selling in the market.

Therefore, the Rs. 120 put option is Out of the Money.

ITM vs ATM vs OTM Options

Understanding the three basic moneyness categories makes options terminology much easier.

These classifications can change whenever the underlying asset price moves.

Do OTM Options Have Value?

Yes.

An OTM option has no intrinsic value, but it can still have extrinsic value, commonly associated with factors such as time remaining until expiration and expected volatility.

For example, imagine a stock is trading at Rs. 100 and a call option has a strike price of Rs. 120.

The option is currently OTM. However, if there are several months before expiration and the stock is highly volatile, traders may still be willing to pay a premium for the possibility that the stock could move above Rs. 120.

This is why an OTM option is not necessarily worthless.

Why Are OTM Options Often Cheaper?

OTM options are generally less expensive than otherwise comparable ITM options because they do not currently contain intrinsic value.

However, a lower premium does not automatically mean a lower-risk investment.

An inexpensive OTM option can lose most or all of its premium if the underlying asset fails to move sufficiently in the expected direction before expiration.

Therefore, traders should consider both potential reward and probability of the expected price movement.

Example of an OTM Call Option

Suppose:

• Current stock price = Rs. 500
• Call strike price = Rs. 550
• Expiration = 3 months
• Option premium = Rs. 10

Because the stock is trading at Rs. 500 while the call strike is Rs. 550, the call is currently OTM.

If the stock remains below Rs. 550 at expiration, the call has no intrinsic value.

But suppose the stock rises substantially before expiration. The option could gain value as the probability of finishing profitably increases.

The important point is that the option buyer does not simply need the stock to rise. The price movement, timing, premium paid, and expiration date all matter.

Example of an OTM Put Option

Consider another example:

• Current stock price = Rs. 500
• Put strike price = Rs. 450
• Expiration = 3 months
• Option premium = Rs. 8

The put is OTM because the market price of Rs. 500 is above the strike price of Rs. 450.

If the stock falls substantially toward or below Rs. 450, the put can become more valuable.

If the stock stays above the strike until expiration, the option may expire without intrinsic value.

What Happens to OTM Options Near Expiration?

Time is particularly important for OTM options.

As expiration approaches, there is less time for the underlying asset to make the required price movement.

If an OTM option remains OTM at expiration, it generally expires with zero intrinsic value.

This is why option buyers need to consider not only:

• Direction
• Price target
• Volatility

but also:

• Time remaining
• Strike price
• Premium paid
• Expiration date

OTM Options and Time Value

An option's premium can contain both intrinsic value and extrinsic value.

For an OTM option:

Intrinsic Value = 0

The premium, if any, therefore reflects extrinsic factors rather than current exercise value.

Time remaining can contribute significantly to an option's premium because more time provides more opportunity for the underlying asset to move into a favorable range.

As expiration gets closer, that time-related component generally declines, all else equal.

OTM Options and Volatility

Volatility is another major factor affecting option prices.

When the underlying asset is expected to experience larger price movements, OTM options can become more valuable because there is a greater possibility of reaching the strike price before expiration.

For example, two otherwise similar OTM call options may have different premiums if one underlying stock has substantially higher expected volatility.

However, higher volatility can increase both potential opportunity and potential risk.

Why Do Traders Buy OTM Options?

Some traders use OTM options because their premiums can be relatively inexpensive compared with ITM options.

Potential reasons include:

1. Lower upfront premium
2. Exposure to a large expected price movement
3. Speculative trading strategies
4. Portfolio or strategy construction
5. Leveraged exposure to an underlying asset

However, an OTM option can also expire worthless.

A low premium should therefore never be confused with low risk.

Major Risks of OTM Options

OTM options can carry substantial risk for option buyers.

1. Expiration Risk

If the underlying asset does not reach a favorable price before expiration, the option may expire worthless.

2. Time Decay

As expiration approaches, an option generally has less time to become profitable. This can reduce its extrinsic value.

3. Volatility Risk

Changes in expected volatility can affect the option premium even when the underlying asset price has not changed significantly.

4. Directional Risk

A trader can correctly predict that a stock will rise but still lose money on an OTM call if the stock does not rise enough, quickly enough, or before expiration.

5. Leverage Risk

Options can provide significant exposure relative to the premium paid. This can magnify both gains and losses.

OTM Does Not Mean "Bad Option"

The term Out of the Money is a technical description, not a judgment about whether an option is good or bad.

An OTM option can move into the money if the underlying asset makes a sufficient price move.

Likewise, an option that is currently ITM can lose value if market conditions change.

Therefore, understanding moneyness is only one part of options analysis.

OTM Options for Beginners: What Should You Learn First?

Before trading options, beginners should understand:

• Call and put options
• Strike price
• Expiration date
• Option premium
• Intrinsic value
• Extrinsic value
• ITM, ATM and OTM
• Implied volatility
• Time decay
• Risk management
• Position sizing
• Break-even price

A strong foundation can help traders understand why an option's price can change even when the underlying stock moves only slightly.

Understanding Options in the Nepalese Stock Market

For investors searching for stock market training in Nepal, understanding derivatives terminology is part of developing broader financial-market knowledge.

Sarbaguna provides practical Share Market Training Nepal programs covering areas such as stock-market fundamentals, technical analysis, fundamental analysis, NEPSE concepts, risk management and practical market education.

If you are a beginner, you can explore the Share Market Training in Nepal resources to build a structured understanding of the Nepalese capital market.

You can also explore Sarbaguna's Stock Market Classes for broader stock-market education.

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Frequently Asked Questions About Out of the Money Options

What is an Out of the Money option?

An Out of the Money (OTM) option is an option that currently has no intrinsic value. A call is OTM when the underlying market price is below its strike price, while a put is OTM when the market price is above its strike price.

Is an OTM option worthless?

Not necessarily. An OTM option has no intrinsic value, but it may still have extrinsic value because of time remaining until expiration and expectations about future price movement and volatility.

What is an OTM call option?

An OTM call option has a strike price above the current market price of the underlying asset.

What is an OTM put option?

An OTM put option has a strike price below the current market price of the underlying asset.

Are OTM options cheaper?

OTM options are often less expensive than comparable ITM options because they currently have no intrinsic value. However, their lower premium does not mean they are risk-free.

Can an OTM option become ITM?

Yes. If the underlying asset moves sufficiently before expiration, an OTM option can become ITM.

What happens if an option expires OTM?

If an option expires OTM, it has no intrinsic value at expiration and the buyer may lose the premium paid for the option, subject to the specific contract and transaction costs.

What is the difference between ITM, ATM and OTM?

ITM means an option currently has intrinsic value. ATM means the strike price is approximately equal to the underlying market price. OTM means the option currently has no intrinsic value.

Why do traders buy OTM options?

Some traders buy OTM options because they can provide exposure to large underlying price movements with a relatively smaller upfront premium. However, the option can expire worthless if the expected movement does not occur.

Is options trading suitable for beginners?

Options can be complex and involve significant risks. Beginners should first understand option pricing, moneyness, expiration, volatility, time decay and risk management before considering options trading.

Final Takeaway

Out of the Money (OTM) describes an option that currently has no intrinsic value.

For calls:

Market Price < Strike Price = OTM

For puts:

Market Price > Strike Price = OTM

Although OTM options may have lower premiums, they can also carry a substantial probability of expiring without intrinsic value. Understanding moneyness, time value, volatility, expiration and risk management is therefore essential before using options.

For investors in Nepal, building a strong foundation in NEPSE, technical analysis, fundamental analysis and stock-market risk management can be an important part of becoming a more informed market participant.

Learn → Analyze → Plan → Manage Risk → Execute → Review.

Disclaimer

This article is for educational and informational purposes only. Options and other financial instruments can involve substantial risk. Examples are simplified and should not be considered personalized investment advice or a recommendation to buy or sell any security.

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