At the money (ATM) is a term used in options trading to describe a situation where the strike price of an option is exactly equal to the current market price of the underlying asset. This means that neither call nor put options have intrinsic value when they are ATM; their value is entirely derived from time value or extrinsic value.
For example, if a stock is trading at ₹100, then a call option and a put option with a strike price of ₹100 are both considered ATM.
How It Works
The concept of ATM in F&O is crucial for understanding options pricing and trading strategies. When an option is ATM:
• Intrinsic Value: The intrinsic value is zero because exercising the option does not yield any profit. For a call option, this means the market price is not above the strike price; for a put option, it means the market price is not below the strike price.
• Extrinsic Value: The entire value of an ATM option comes from its extrinsic value, which reflects factors such as time until expiration and implied volatility. As expiration approaches, the extrinsic value diminishes due to time decay.
• Sensitivity to Price Changes: ATM options are highly sensitive to changes in the underlying asset’s price. They typically have a delta of approximately ±0.50, meaning that for every ₹1 change in the underlying asset’s price, the option’s price will change by about ₹0.50.
Consider a stock currently trading at ₹150. If you purchase an ATM call option with a strike price of ₹150, here’s how it could play out:
• If the stock price rises to ₹160, you can exercise your option to buy at ₹150 and sell at ₹160, realizing a profit of ₹10 per share (minus any premium paid for the option).
• Conversely, if the stock price falls to ₹140, your call option would expire worthless since you wouldn’t exercise it at a loss. Your loss would be limited to the premium paid for the option.
How to use ATM in Trading Strategies
ATM options are often used in various trading strategies due to their unique characteristics:
• Straddles and Strangles: Traders may buy both an ATM call and put option simultaneously to profit from significant price movements in either direction.
• High Trading Volume: Options that are ATM tend to see higher trading volumes as traders anticipate volatility, making them attractive for short-term strategies.
• Risk Management: While they offer opportunities for profit through volatility, ATM options also carry higher risks compared to in-the-money (ITM) options since they lack intrinsic value at purchase.
How is ATM different from ITM and OTM in terms of risk and reward?
When trading options, understanding the distinctions between At The Money (ATM), In The Money (ITM), and Out Of The Money (OTM) options is crucial for assessing risk and reward. Each type of option has unique characteristics that influence their potential outcomes.
• In The Money (ITM): An option is considered ITM when it has intrinsic value. For a call option, this means the strike price is below the current market price of the underlying asset. For a put option, it means the strike price is above the current market price.
• At The Money (ATM): An option is ATM when its strike price is equal to the current market price of the underlying asset. ATM options have no intrinsic value; their worth is derived solely from extrinsic value.
• Out Of The Money (OTM): An option is OTM when it has no intrinsic value. For a call option, this occurs when the strike price is above the current market price; for a put option, it occurs when the strike price is below the market price.
Risk and reward analysis for ATM, ITM, OTM
| Option type |
Risk level
|
Reward potential
|
Characteristics
|
| ITM |
Low |
Moderate |
Less risky because they have intrinsic value. They provide some return with minor favourable movements but require a higher upfront premium. This leads to lower percentage returns compared to OTM options |
| ATM |
Moderate |
Balanced |
Offer a balanced approach to risk and reward. They are sensitive to price changes and have high extrinsic value. If the underlying asset does not move significantly, ATM options can expire worthless, resulting in total loss of the premium paid |
| OTM |
High |
High |
They have lower premiums since they lack intrinsic value and require significant movement in the underlying asset’s price to become profitable. However, if such movement occurs, OTM options can yield substantial percentage returns |
Factors to consider when choosing between ITM, ATM, and OTM options
When deciding between In The Money (ITM), At The Money (ATM), and Out Of The Money (OTM) options, traders should evaluate several key factors that influence their risk tolerance, market expectations, and overall trading strategy.
1. Risk Tolerance
• ITM Options: Generally considered less risky due to their intrinsic value. They provide a buffer against total loss if the underlying asset moves unfavorably. Suitable for conservative traders looking for steady returns.
• ATM Options: Offer a balanced risk-reward profile. While they have no intrinsic value at the time of purchase, they can still provide significant returns if the underlying asset moves favorably. They are suitable for traders with moderate risk tolerance.
• OTM Options: High-risk, high-reward instruments. They have no intrinsic value and require significant price movement in the underlying asset to become profitable. Best for aggressive traders willing to accept the possibility of total loss.
2. Market Expectations
• Bullish Outlook: If you expect a strong upward movement in the underlying asset, OTM options may be appealing due to their potential for high returns. Conversely, if you expect moderate increases, ATM options could be more suitable.
• Bearish or Sideways Outlook: For a bearish view or if you anticipate minimal movement, ITM options might be preferable as they provide some return even in sideways markets.
3. Time Until Expiration
• Time Decay (Theta): ATM options experience rapid time decay as expiration approaches, which can erode their value quickly if the underlying asset does not move significantly. ITM options tend to hold value better over time due to their intrinsic component.
• Longer Time Horizons: If you have a longer time until expiration, OTM options may be more attractive as they allow for potential price movements without immediate pressure from time decay.
5. Premium Costs
• Cost of Entry: ITM options typically have higher premiums due to their intrinsic value, making them more expensive upfront. ATM options are usually priced in between ITM and OTM options, while OTM options are the cheapest but come with higher risk.
• Return on Investment: Assess the potential return relative to the premium paid. OTM options may offer higher percentage returns if the underlying asset moves favourably, but they also carry a higher likelihood of expiring worthless.
Wrapping up
Understanding ATM options is essential for traders looking to navigate the complexities of options markets effectively. They provide opportunities for profit through volatility while also presenting risks that must be carefully managed.
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