Out of the money (OTM)

Out of the money (OTM) describes an option with no intrinsic value: a call whose strike price is above the current stock price, or a put whose strike is below it. Its entire premium is time value.

How it works

Because an OTM option has no intrinsic value, it is worthless at expiration unless the stock moves past the strike. Its price comes entirely from the chance that happens before time runs out, which depends on time to expiration and implied volatility.

OTM options have a delta below 0.50 in absolute terms. Traders often treat delta as a rough proxy for the probability the option finishes in the money, so a 0.15-delta call is loosely priced as roughly a 15% chance.

Why it matters for traders

• Cheap leverage, low hit rate. OTM options cost little and can return many times their price on a big move, but most expire worthless.
• Time decay. All of an OTM option's value is time value, so it erodes steadily if the stock does not move.
• A signal source. Large, sudden buying of short-dated OTM calls or puts is a classic form of unusual options activity, because someone is paying for a big move in a short time.
• For sellers. Selling OTM options collects premium with a high probability of keeping it, in exchange for exposure to large, rare losses.

Example

Fabrikam Software (FBKM) trades at $30 two weeks before earnings.

• The $35 call is $5 OTM and costs $0.40 ($40 per contract).
• If FBKM jumps to $38 after earnings, the call is worth at least $3.00 at expiration, about 7.5 times its cost.
• If FBKM finishes at $34, the call expires worthless and the buyer loses $40.

FAQ

Why do out-of-the-money options lose value so fast?

All of their value is time value, which decays every day and accelerates near expiration. If the stock is not moving toward the strike, there is nothing else holding the price up.

Can an out-of-the-money option still be worth selling before expiration?

Yes. If the stock moves toward the strike or implied volatility rises, an OTM option can gain value and be sold at a profit before it ever goes in the money.