Out Of The Money
An option with no intrinsic value, whose entire premium is time and volatility.
Also called: otm
Written by Javier Sánchez Ros
In plain language
A call is out of the money when the underlying is below the strike; a put when it is above.
These options are cheap because they are unlikely to pay off. The low price is the market’s estimate of probability, not a discount.
They offer the largest percentage gains when they work, and expire worthless most of the time.
Worked through
Twenty weekly lottery tickets at $0.18
- Cost per contract
- $18
- Twenty contracts
- $360
- Move required to break even
- +9%, within days
- Most likely outcome
- $0
Three hundred and sixty dollars does not feel like a serious risk, and that is the whole problem. The position is not risky because it is large; it is risky because the likeliest single outcome is losing all of it, and that outcome arrives most weeks.
The maths is not hidden. The option costs eighteen dollars because the market judges a 9%-plus move in a few days to be improbable, and improbable things are improbable whether or not the ticket is cheap. Buying twenty of them does not diversify anything — it is one bet, taken twenty times, on the same move.
What makes it so common is the shape of the payoff. The rare win is spectacular and memorable, the frequent total losses are small and forgettable, and the memory of the one overwhelms the arithmetic of the many.
Used deliberately these contracts have a place — as a small, explicitly speculative slice of an account, sized as money already spent. Used as a way to make a small account grow quickly, they are the fastest route to it not growing at all.
Why it matters
Out-of-the-money options are the most common way beginners lose money in options: the lottery-ticket payoff obscures how often the outcome is a total loss.
Common mistakes
- Buying far out-of-the-money options because more contracts fit the budget.
- Assuming a directional call is enough. The move must also be large enough and fast enough.
Keep exploring
These concepts are connected. Understanding one usually makes the next one easier.
An option that currently has intrinsic value.
The part of an option’s premium beyond intrinsic value, reflecting time and volatility.
How much value an option loses per day purely from the passage of time.
How much an option’s price moves for a $1 move in the underlying.
The price at which an option contract can be exercised.