Understanding Call Option Moneyness: In, At, and Out-of-the-Money

Let’s talk about call options, and specifically how we determine if they are in-the-money, at-the-money, or out-of-the-money. Imagine you have a coupon that gives you the right to buy your favorite brand of coffee beans for ten dollars a bag. This coupon is a bit like a call option. A call option gives you the right, but not the obligation, to buy an underlying asset, like shares of a company or even those coffee beans, at a specific price, known as the strike price, on or before a certain date.

Now, whether your coffee bean coupon is valuable right now depends on the current price of those beans in the store. This current price is what we call the underlying asset’s price. Let’s say the strike price on your coupon is ten dollars.

If, when you go to the store, you find that those coffee beans are currently selling for twelve dollars a bag, your coupon is quite valuable! You can use your coupon to buy them for ten dollars, instantly saving two dollars per bag. In options terms, this is called being “in-the-money.” A call option is in-the-money when the current market price of the underlying asset is higher than the option’s strike price. Essentially, if you exercised your option right now, you would make a profit. This profit potential is called intrinsic value. In our coffee example, your coupon has two dollars of intrinsic value because you can buy something worth twelve dollars for ten dollars.

On the other hand, what if you went to the store and found that those coffee beans were selling for exactly ten dollars a bag? Your coupon is still valid; it still gives you the right to buy them for ten dollars. But, it doesn’