Chapter 2 of 9
Moneyness, intrinsic value and time value
Separate ITM/ATM/OTM from profitability, and explain why two options on the same underlying can behave differently.
In this chapter
Moneyness compares reference price and strike #
A call is in the money when the relevant underlying reference exceeds strike, while a put is in the money when strike exceeds that reference. At-the-money and near-the-money usage can vary with whether the reference is spot or forward. State the convention used.
Moneyness does not include the price originally paid. An in-the-money option can still represent a net loss for its buyer. An out-of-the-money option has no current intrinsic value under that reference but can have a premium while time and uncertainty remain.
Intrinsic and residual value #
For an equity-style illustration, call intrinsic value is max(S − K, 0) and put intrinsic is max(K − S, 0). Premium minus intrinsic value is commonly called time value or extrinsic value. Actual pricing also reflects exercise style, rates, dividends and market frictions.
An apparent negative extrinsic value should prompt a check of the reference, quote timestamps, liquidity and exercise/financing conventions rather than an instant conclusion that free money is available. Some simplified relationships need adjustment for the actual product.
Decision lab: Moneyness depends on the reference and the clock #
An out-of-the-money option can have value before expiry because future exercise outcomes remain uncertain. The absence of intrinsic value is not proof that the premium is free money for the writer. Nor does deep-in-the-money status make a quoted option liquid.
Compare intrinsic value and remaining premium for three fictional strikes using one contemporaneous underlying reference. State whether the instrument references spot or futures and identify exercise conventions. Recalculate at expiry without assuming earlier time value must survive.
Hypothetical worked example
ITM does not mean profitable
A fictional put has strike 100 and was bought for 12. With the underlying reference at 94, intrinsic value is 6. If its current premium is 9, the residual above intrinsic is 3.
The put is in the money but the buyer would lose 3 per unit by selling at 9 before costs. If it expires at 94, the intrinsic payoff of 6 produces an expiry P&L of −6 relative to the original premium.
For a different strike or expiry, both intrinsic and residual value may differ. Comparing premiums without matching those terms does not establish a better trade.
Common mistakes
- Using ITM as a synonym for profitable.
- Calling an OTM option safe because its quoted premium is small.
Does an in-the-money option necessarily give its buyer a profit?
Make this chapter useful
Can you defend the reasoning?
Before moving on, answer the self-check in your own words and write why each alternative fails. Use the worked example to test that explanation. Then apply it in the module research task; keep the assumptions and the evidence that could change your answer.
Sources and further reading
- NSE individual-security derivatives specifications ↗
- NSE Clearing: equity derivatives margins ↗
- SEBI investor education ↗
Further-reading references from the curriculum source list. Contract sizes, expiry calendars, settlement references, margin parameters and tax treatment can change; verify the current operative documents for the actual product. Worked figures are illustrative, not current quotes.
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