Moneyness Explained

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Definitions for MONEYNESS
MONEYNESS

Here are all the possible meanings and translations of the word MONEYNESS.

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The degree to which a derivative security is in the money, because of the relationship of the price of the underlying security to a conversion price or exercise price.

As an option’s expiration date approaches only its moneyness has value.

The degree to which an asset approximates cash in its ready liquidity and the low transactions costs in realizing that liquidity.

In good times everything seems to have moneyness; in bad times, some money doesn’t have much moneyness.

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In finance, moneyness is the relative position of the current price of an underlying asset with respect to the strike price of a derivative, most commonly a call option or a put option. Moneyness is firstly a three-fold classification: if the derivative would make money if it were to expire today, it is said to be in the money, while if it would not make money it is said to be out of the money, and if the current price and strike price are equal, it is said to be at the money. There are two slightly different definitions, according to whether one uses the current price or future price, specified as “at the money spot” or “at the money forward”, etc. This rough classification can be quantified by various definitions to express the moneyness as a number, measuring how far the asset is in the money or out of the money with respect to the strike – or conversely how far a strike is in or out of the money with respect to the spot price of the asset. This quantified notion of moneyness is most importantly used in defining the relative volatility surface: the implied volatility in terms of moneyness, rather than absolute price. The most basic of these measures is simple moneyness, which is the ratio of spot to strike, or the reciprocal, depending on convention. A particularly important measure of moneyness is the likelihood that the derivative will expire in the money, in the risk-neutral measure. It can be measured in percentage probability of expiring in the money, which is the forward value of a binary call option with the given strike, and is equal to the auxiliary N term in the Black–Scholes formula. This can also be measured in standard deviations, measuring how far above or below the strike price the current price is, in terms of volatility; this quantity is given by d2. Another closely related measure of moneyness is the Delta of a call or put option, which is often used by traders but actually equals N, not N, and there are others, with convention depending on market.

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Moneyness

In options trading, moneyness is the relative position of the current market price of an underlying asset with respect to the strike price of the option.

When an option is profitable and makes sense to be exercised we say that it is “in the money” (ITM). Call option is in the money when its strike price is below the current market quotes of the underlying asset. A put option is in the money when its strike price is above the current market quotes of the underlying asset.

If the option position is losing and there is no point to the be exercises we say that it is “out of the money” (OTM). Call option is out of the money when its strike price is above the current market quotes of the underlying asset. A put option is out of the money when its strike price is below the current market quotes of the underlying asset.

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When the current market price is equal to the strike of the option we say that it is “at the money” (ATM).

MONEYNESS

A derivative relating its strike price to the price of a given asset. It refers to the intrinsic value of an option at present. There are three common forms of moneyness: in the money, out of the money, and at the money When an investor is “in the money,” they stand to acquire gains by exercising the option. When an investor is “out of the money,” they stand to endure profit losses. When an investor is “at the money,” they stand to break even though the option is exercised.

Moneyness of an Option

One of the important concepts in options trading is the moneyness of the option. The moneyness represents the relationship between the price of the underlying and the strike price of the option.

An option can be in-the-money, at-the money, or out-of-the-money.

Moneyness of a Call Option

An option is said to be in-the-money, when it produces more cash in flow than outflow.

In case of a call option, the option will be in-the-money if it’s strike price is less than the underlying’s spot price. For example, if a call option has a strike price of $20, while the underlying is currently selling at $25, then the call option holder can exercise the option and pay only $20 for a $25 worth of stock.

The same call option would be at-the-money if both the strike price and the underlying stock price are the same, i.e., no profit/no loss.

If the call option’s strike price was $20, but the underlying was currently selling at $15, there is no benefit in exercising the option, and the holder is better was buying the stock directly from the market. In this situation, the option will be said to be out-of-the-money.

Moneyness of a Put Option

In case of a put option, the option will be in-the-money if the underlying’s price is below the option’s strike price. So, if the put option’s strike price is $20, and the underlying’s spot price is $15, then the option is in-the-money. This is because the put option holder can exercise the put option to sell the underlying at $20, which is actually worth just $15 in the market.

Similarly, a put option will be out-of-the money if the underlying price is higher than strike price, because in this case the option holder will earn more if he puts (sells) the bond directly in the market, rather than exercising the option.

In both the cases, an at-the-money option can be looked at as an out-of-the-money option because exercising it does not earn any money for the option holder.

It is not necessary that an in-the-money option is always exercised. However, an out-of-the money option is never exercised.

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