Definition
The term deep out-of-the-money refers to an option that has no intrinsic value and the strike price is significantly different than the market price of the asset. The concept of moneyness helps an investor to understand the position of an underlying asset relative to an option's strike price.
Explanation
When an investor holds an option they are provided with the right, but not an obligation, to buy or sell the underlying asset at the strike price on or before the contract's expiration date. In the case of a call option, the holder has the right to buy the underlying asset, while a put option confers the right to sell the underlying.
An option that is deep out-of-the-money (OTM) has an exercise price that is significantly higher, or lower, than the current market price of the underlying asset. An option that is deep out-of-the-money will trade at a premium that accounts only for the time value of the option itself, since the holder would have a loss on the transaction if they were to exercise their option to buy or sell the underlying asset.
For example, a put option that is deep out-of-the-money has a strike price that is significantly less than the current market price of the underlying security or asset, while a call option that is deep out of the money has a strike price that is significantly higher than the current market price of the underlying. In both examples, the investor would lose money if they exercised their rights under the agreement.
The only value a deep out-of-the-money option has is a function of time. Although extremely unlikely, a deep OTM option could go in-the-money over time. However, as the time to expiration approaches, the premium for an option that remains out-of-the-money will approach zero.
Related Terms
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The term margin refers to the minimum level of assets required to support an investment position. When an investor buys securities on margin, they are funding a portion of the purchase price with funds borrowed from a broker.
Moneyzine EditorNovember 6th, 2024
The term maintenance margin refers to the minimum equity portion of the purchase price the investor must maintain when they purchase securities on margin. Maintenance margin thresholds are enforced by brokers and established by the Federal Reserve Board.Moneyzine EditorJanuary 24th, 2024
The term initial margin refers to the portion of the purchase price the investor must pay when buying securities on margin. Initial margin thresholds are enforced by brokers and established by the Federal Reserve Board.Moneyzine EditorNovember 6th, 2024
The term lambda refers to a measure of the percentage change in the premium paid for an option for every percentage change in the price of the underlying asset. Lambda allows the investor to understand the sensitivity of an option's price to a change in the underlying asset's price.Moneyzine EditorNovember 6th, 2024
The term kappa refers to the change in the premium paid for an option for every one percent change in the volatility of the underlying asset. Kappa allows investors to understand the impact a change in volatility will have on an option's value.Moneyzine EditorJanuary 23rd, 2024- The term out-of-the-money refers to an option that has no intrinsic value. The concept of moneyness helps an investor to understand the position of an underlying asset relative to an option's strike price.Moneyzine EditorNovember 6th, 2024
- The term near-the-money refers to an option that is close to having intrinsic value based on the strike price of the option relative to the market price of the underlying asset. The concept of moneyness helps an investor to understand the position of an underlying asset relative to an option's strike price.Moneyzine EditorNovember 6th, 2024
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