In options trading, moneyness compares the option’s strike price with the stock price. It tells traders whether a contract is in, at, or out of the money and hints at the risk of exercising or holding the option.
- In-the-money (ITM)
- Describes an option with intrinsic value. A call option is ITM when its strike price is below the stock price. A put option is ITM when its strike price is above the stock price.
- At-the-money (ATM)
- Occurs when the stock price and strike price are approximately equal. The option has minimal or no intrinsic value but may retain time value.
- Out-the-money (OTM)
- Means the stock price is unfavorable relative to the strike price. A call option is OTM when its strike price is above the stock price. A put option is OTM when its strike price is below the stock price. Exercising the option would not yield a profit.
Moneyness is measured as \(S/K\) where \(S\) is the stock price and \(K\) is the strike. In the Black-Scholes model an at-the-money option has \(S/K = 1\).
As moneyness changes, Option Delta and Option Gamma shift as well.
Delta tracks how much an option’s price moves for a $1 change in the stock. Out-of-the-money calls start near zero. Delta climbs toward one as moneyness increases, so the option behaves more like the stock. The chart below shows this steady rise.
Gamma measures how quickly delta itself changes. It peaks at
the at-the-money point where the delta curve is steepest. Gamma
fades as contracts move deeper in or out of the money, meaning
delta becomes more stable. The chart also plots gamma to highlight
its spike around \(S/K = 1\).
Understanding where an option sits on this scale helps when choosing a Option Strike Price, gauging price sensitivity with delta, and managing hedge adjustments through gamma. Apply the concept in a Covered Call.