Out-Of-The-Money Option: A Comprehensive Guide

What Is an Out-Of-The-Money Option?

An out-of-the-money (OTM) option is a call or put contract whose strike price is unfavorable compared with the current market price of the underlying asset. For a call, the strike lies above today’s spot price; for a put, the strike sits below it. Because exercise would yield no immediate profit, OTM options trade at pure time value only.

How to Identify OTM Calls and Puts

To quickly spot an OTM contract, compare the strike to the last traded price. If Apple shares are at $180, a $200 call is out of the money, while a $160 put is likewise OTM. Delta, the sensitivity of an option to price changes, typically hovers around 0.30 or lower for these distant strikes, signaling a lower probability of finishing in-the-money.

Why Traders Use OTM Options

Many traders purposely buy inexpensive OTM options to secure leveraged exposure at minimal upfront cost. Small account holders can participate in big-ticket stocks, while hedgers can protect portfolios discreetly with far-out puts. When volatility expands or the underlying rallies hard, a cheap OTM contract can appreciate dramatically, delivering asymmetric payoff potential versus limited, predefined risk.

Risks and Rewards

Yet the low premium masks a unique hazard: time decay. Because OTM options lack intrinsic value, theta relentlessly erodes their price each day the market fails to move. Additionally, wide bid-ask spreads and sudden volatility crushes can make it difficult to exit profitably. Traders should therefore size positions modestly and pair them with a clear catalyst and timeline.

Key Takeaways

The bottom line:

• OTM means strike is beyond the current market price.
• Premium consists entirely of time and volatility value.
• Low cost delivers high leverage but also higher probability of expiration worthless.
• Successful OTM strategies rely on strong directional conviction and disciplined exits.