In financial terms, Out of the money (OTM) is a term used to describe an option contract that only contains intrinsic value. As a general rule:
- An out of the money call option will have a strike price that is higher than the market price of bitcoin.
- An out of the money put option has a strike price that is lower than the market price of bitcoin.
An investor wants to buy a call option, choosing a call option with a $10,000 strike price. The option expires in five months and costs $5. This gives the investor the right to buy a bitcoin before the option expires. The total cost of the option is $5.
Let’s say bitcoin is currently trading at $9,000. When buying the option, there is no reason for the investor to exercise the option because. Otherwise, he would have to pass $10,000 worth of bitcoin when the current market price is $9,000, making a $1,000 loss.
Even though this option would be currently OTM, it doesn’t mean it is worthless yet since the expiration date is in 5 months. The investor simply paid $5 hoping that bitcoin will appreciate above $10,000 within the next five months.
Now, if the option is OTM at expiry date it then becomes worthless. However, prior to expiry, that option will have some extrinsic value which is reflected in the premium (or cost of the option). It could be the case that the price of bitcoin never goes above $10,000 in this example, but the premium of the option might increase to $10, $20, or more if it gets closer to the strike price. In that case the investor would still be able to make some profit by selling the option at a higher premium than he had previously paid for.
Other two possible scenarios are:
- Bitcoin price moves up to $11,000. The option is now ITM and it is worth exercising. If the investor exercises the call option and sells the option right away, he will be making $995. This is Bitcoin Price - Option Strike Price - Premium = ($11,000 - $10,000 - $5).
- If Bitcoin price goes up to $10,003, the call option would be in the money but because of the price he paid for the premium, if he was to exercise the option he would still be losing $2. However, if he doesn’t exercise the option, he would lose $5.
*These options will have a delta less than 50.0.