Explain what an option's moneyness means
The idea
An option is in the money when exercising it immediately would produce a positive payoff, at the money when the underlying sits at the exercise price, and out of the money otherwise. For a call, in the money means the underlying is above the exercise price; for a put the relation reverses. Moneyness describes only the intrinsic component — an out-of-the-money option still has a positive price whenever time remains, because the underlying may yet move. Moneyness is therefore a statement about where the underlying is now, not about whether the option is worth anything.
A practice question
When is a put option in the money?
- When the underlying price is above the exercise priceWhy not: That is when a call is in the money. A put gains from the underlying being below the strike.
- When the underlying price is below the exercise price — correct
- When the premium exceeds the exercise priceWhy not: Compares two prices that have no bearing on each other. Moneyness is about the underlying against the strike.
The put holder sells at the exercise price, so the option has value when the market price is lower. The relation is the mirror of the call's.
A harder one
Why does an out-of-the-money option still trade at a positive price?
- Because exchanges set a minimum priceWhy not: Exchanges set tick sizes, not values. A genuinely worthless option would trade at the minimum tick and attract no buyers.
- Because the writer must be compensated for marginWhy not: Margin is a cost to the writer, but the option's value comes from what it might become worth.
- Because time remains for the underlying to move into the money — correct
The price of an unexpired option includes time value, which reflects the chance of a favourable move. Only at expiry does the price collapse to intrinsic value.
The hardest tier
A call and a put on the same underlying share an exercise price of 80, and the underlying trades at 80. What is true of their moneyness and intrinsic values?
- Both are at the money with zero intrinsic value, yet both have positive prices while time remains — correct
- Both are in the moneyWhy not: In the money requires intrinsic value, and at the strike both have none.
- The call is in the money and the put is out of the moneyWhy not: That would require the underlying to be above 80. At exactly 80 neither has any intrinsic value.
At the money means the underlying equals the exercise price, so neither has intrinsic value. Their prices are entirely time value, and put-call parity relates the two.
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