Now that you are comfortable calculating “Profit/Loss at expiry” to buy options, I would like to show you how changing the strike of the option affects the overall value of it. The strike of an option will always be in one of three states: In-the-money (ITM), at-the-money (ATM), or out-of-the-money (OTM).
Since there are several news events for both the euro and the greenback on Monday, EUR/USD will be potentially more volatile. When buying options, increasing volatility in the future is good. So let’s evaluate whether you would want to buy your options at-the-money, in-the-money, or out-of-the-money (terms you will frequently hear when trading options).
• An option is at-the-money (ATM) when the strike rate equals the underlying market rate. For example, if EUR/USD is trading at 1.1200 and you buy a Call option with strike 1.1200 the option is ATM.
• An option is in-the-money (ITM) when the strike rate is better than the underlying market rate. For example, if EUR/USD is trading at 1.1200 and you buy a Call with strike 1.1100 the option would be considered ITM because 1.1100 is a better buy rate than 1.1200.
• An option is out-of-the-money (OTM) when the strike rate is worse than the underlying market rate. For example, if EUR/USD is trading at 1.1200 and you buy a Call with strike 1.1300 the option would be considered OTM because 1.1300 is a worse buy rate than 1.1200.
These states are known as an option’s ‘moneyness’.
When an option is in-the-money (ITM), it is more valuable, i.e. its premium is higher. Hence, ITM options are the most expensive to buy, whereas out-of-the-money (OTM) options are cheaper. Paying more for an option means you are risking more, however an ITM option has a higher probability of returning a profit. Buying an OTM option is a smaller risk, but the probability of profit is lower. In each trade, you enter a strike rate depending on your market outlook and risk appetite.
When you buy a Call option with a strike equal to the market rate, it is at-the-money (ATM). If the market rises, the option will become ITM since the buy price of the strike is cheaper than the market. But if the market falls, the option will become OTM. The diagram below demonstrates this concept.
In the ATM buy call option image above, the underlying EUR/USD rate was trading at 1.12252 and valued at 345.47 USD.
Setting an option with a strike of 0% means the strike will also be 1.12252.
In the OTM buy call option above, a strike price +2% above market has been selected. This means the trader is reserving a worse rate than what is currently available in the market and the following happens – the value of the option decreases to 54.50 USD.
In the ITM buy call option above, a strike price -2% below market has been selected. This means the trader is reserving a better rate than the market and the following happens – the value of the option increases to 1,190.11 USD.
Note: A Put option, with the same strike rate, will always be in a different state to the Call option unless the strike rate equals the market, then both the Put and Call will be at-the-money (ATM). The table below shows the different states of a Put and Call as the strike level in relation to market level changes.
Since there are several news events for both the euro and the greenback on Monday, EUR/USD will be potentially more volatile. When buying options, increasing volatility in the future is good. So let’s evaluate whether you would want to buy your options at-the-money, in-the-money, or out-of-the-money (terms you will frequently hear when trading options).
• An option is at-the-money (ATM) when the strike rate equals the underlying market rate. For example, if EUR/USD is trading at 1.1200 and you buy a Call option with strike 1.1200 the option is ATM.
• An option is in-the-money (ITM) when the strike rate is better than the underlying market rate. For example, if EUR/USD is trading at 1.1200 and you buy a Call with strike 1.1100 the option would be considered ITM because 1.1100 is a better buy rate than 1.1200.
• An option is out-of-the-money (OTM) when the strike rate is worse than the underlying market rate. For example, if EUR/USD is trading at 1.1200 and you buy a Call with strike 1.1300 the option would be considered OTM because 1.1300 is a worse buy rate than 1.1200.
These states are known as an option’s ‘moneyness’.
When an option is in-the-money (ITM), it is more valuable, i.e. its premium is higher. Hence, ITM options are the most expensive to buy, whereas out-of-the-money (OTM) options are cheaper. Paying more for an option means you are risking more, however an ITM option has a higher probability of returning a profit. Buying an OTM option is a smaller risk, but the probability of profit is lower. In each trade, you enter a strike rate depending on your market outlook and risk appetite.
Buying an at-the-money (ATM) Call option
When you buy a Call option with a strike equal to the market rate, it is at-the-money (ATM). If the market rises, the option will become ITM since the buy price of the strike is cheaper than the market. But if the market falls, the option will become OTM. The diagram below demonstrates this concept.
Example of buying Long Call option – ATM, OTM, ITM
The following three images depict EUR/USD buy call options ATM, OTM, and ITM.In the ATM buy call option image above, the underlying EUR/USD rate was trading at 1.12252 and valued at 345.47 USD.
Setting an option with a strike of 0% means the strike will also be 1.12252.
In the OTM buy call option above, a strike price +2% above market has been selected. This means the trader is reserving a worse rate than what is currently available in the market and the following happens – the value of the option decreases to 54.50 USD.
In the ITM buy call option above, a strike price -2% below market has been selected. This means the trader is reserving a better rate than the market and the following happens – the value of the option increases to 1,190.11 USD.
Note: A Put option, with the same strike rate, will always be in a different state to the Call option unless the strike rate equals the market, then both the Put and Call will be at-the-money (ATM). The table below shows the different states of a Put and Call as the strike level in relation to market level changes.
Editors’ Picks
EUR/USD climbs to daily highs near 1.1820
EUR/USD now picks up pace and advances to the area of daily peaks north of the 1.1800 barrier at the end of the week. The pair’s decent move higher comes against the backdrop of a generalised lack of direction in the FX galaxy and the mild offered stance in the US Dollar.
GBP/USD trims losses, retests 1.3460
After briefly challenging its key 200-day SMA near 1.3440, GBP/USD now manages to regain some balance and revisit the 1.3460 zone on Friday. Cable’s pullback comes as the selling pressure on the Greenback gathers traction, reigniting some recovery in the risk-linked space.
Japanese Yen gives back half of early gains against USD ahead of US PPI data
The Japanese Yen (JPY) surrenders half of its early gains against the US Dollar (USD) during the European trading session on Friday. The USD/JPY pair rebounds to near 155.90 as the JPY falls back, but is still 0.15% down.
Editors’ Picks
EUR/USD: Fed calm, ECB steady, but the Dollar still leads Premium
EUR/USD is still struggling to find real traction. The pair has tried to stabilise, but momentum keeps fading, leaving the door open to further weakness.
Gold: Falling US yields, geopolitics help XAU/USD hold ground Premium
Gold (XAU/USD) gained traction and climbed above $5,200, ending the fourth consecutive week in positive territory. The next round of US-Iran talks and crucial macroeconomic data releases from the US will be watched closely by market participants in the short term.
GBP/USD: Will Pound Sterling defend key 1.3450 support ahead of US jobs data? Premium
The Pound Sterling (GBP) entered a bearish consolidation phase against the US Dollar (USD), after having tested critical support near the 1.3450 level on several occasions.
Bitcoin: Another month of losses, and it’s been five
Bitcoin (BTC) price is stabilizing around $68,000 at the time of writing on Friday, but the Crypto King is poised to close February on a fragile footing, marking its fifth consecutive month of losses since October and a rare start to the year with back-to-back monthly corrections.
US Dollar: At a crossroads; Fed steady, tariffs in flux Premium
The US Dollar’s (USD) upward momentum from the previous week seems to have encountered a tough nut to crack in the 98.00 region, as measured by the US Dollar Index (DXY).
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