Explained: Option terminologies- In the money, At the money and Out of the money.

An option contract is one of the derivative contracts that is used as a risk management strategy by investors and traders to protect themselves against losses.  

It gives the buyer of the option (a.k.a investor) a right, but not an obligation to buy or sell an underlying asset on a future date, and at a pre-determined price. On the other hand, the seller of the option (a.k.a writer) is obligated to buy or sell an underlying asset at the pre-determined price in case the buyer of the option decides to exercise his right. This pre-determined price is called the exercise price or strike price. 

An option to buy the security in known as a call option. The buyers of such option have a bullish view on the market and expect that the underlying asset's price will rise and close above the strike price by the expiration date of the option.  

Similarly, an option to sell a security is known as a put option. The sellers of such option have a bearish view on the market and expect that the underlying asset's price will fall and close below the strike price by the expiration date of the option. 

In the money- 

An option is said to be ‘In the money’ when: 

1) The strike price is less than the market price (in case of call option). Here, the buyer has the opportunity to buy the option at a price that is below its market price. 

2) The strike price is greater than the market price (in case of put option). Here, the seller has the opportunity to sell the option at a price that is above its market price. 

‘In the money’ option contracts have higher premiums than other option contracts. This is because they have an intrinsic value and an extrinsic value. Due to this attribute, the option rights can be exercised immediately.  

At the money- 

An option is said to be ‘At the money’ when the strike is equal to the market (in case of both call and put option). Here, both the buyer/seller has the opportunity to buy/sell the option at a price that is equal to its market price. 

Out of the money- 

An option is said to be ‘Out of the money’ when: 

1) The strike price is greater than the market price (in case of call option). Here, the buyer buys the option at a price that is above its market price. 

2) The strike price is less than the market price (in case of put option). Here, the seller sells the option at a price that is below its market price. 

‘Out of the money’ option contracts have no intrinsic value and hence, they have lower premiums. However, they do have an extrinsic value. 

It should be noted that no option contract is better than the other. And that the option opted by the investor/ trader comes down to the strategy he is implementing.