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 trades above 1.0700 after EU inflation data
EUR/USD regained its traction and climbed above 1.0700 in the European session. Eurostat reported that the annual Core HICP inflation edged lower to 2.7% in April from 2.9% in March. This reading came in above the market expectation of 2.6% and supported the Euro.
GBP/USD recovers to 1.2550 despite US Dollar strength
GBP/USD is recovering losses to trade near 1.2550 in the European session on Tuesday. The pair rebounds despite a cautious risk tone and broad US Dollar strength. The focus now stays on the mid-tier US data amid a data-light UK docket.
Gold price remains depressed near $2,320 amid stronger USD, ahead of US macro data
Gold price (XAU/USD) remains depressed heading into the European session on Tuesday and is currently placed near the lower end of its daily range, just above the $2,320 level.
XRP hovers above $0.51 as Ripple motion to strike new expert materials receives SEC response
Ripple (XRP) trades broadly sideways on Tuesday after closing above $0.51 on Monday as the payment firm’s legal battle against the US Securities and Exchange Commission (SEC) persists.
Mixed earnings for Europe as battle against inflation in UK takes step forward
Corporate updates are dominating this morning after HSBC’s earnings report contained the surprise news that its CEO is stepping down after 5 years in the job. However, HSBC’s share price is rising this morning and is higher by nearly 2%.
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