Out Of The Money (OTM): Meaning and Use in Options
Out Of The Money (OTM): A Practical Guide
Out Of The Money, or OTM, options have a strike price that is not yet useful to the buyer. A call is OTM when its strike is above the current price. A put is OTM when its strike is below the current price. OTM options are cheap but need a strong move to gain value.
This guide explains what OTM means and how Indian traders can use OTM options well.
What Is an OTM Option?
An OTM option has no intrinsic value yet. Its price is made up only of time value and implied volatility.
- OTM call: strike is above the current price
- OTM put: strike is below the current price
The further OTM the option is, the lower the cost and the lower the chance of profit.
OTM Call Example
Suppose Nifty trades at 22,000.
- 22,100 call: slightly OTM
- 22,300 call: moderately OTM
- 22,800 call: deep OTM
These calls gain value only if Nifty rises through the strike before expiry.
OTM Put Example
Suppose Nifty trades at 22,000.
- 21,900 put: slightly OTM
- 21,700 put: moderately OTM
- 21,200 put: deep OTM
These puts gain value only if Nifty falls through the strike before expiry.
How OTM Options Behave
OTM options have:
- Lower cost (premium)
- Lower delta (often below 0.4)
- Higher time value as a share of price
- Faster time decay near expiry
This means small price moves of the underlying may not move the option much.
When to Use OTM Options
OTM options work well when:
- You expect a large, fast move
- You want to limit cash outlay
- You can accept lower probability of profit
- You plan event-based trades
Traders often use OTM options around major news, earnings, or budgets.
OTM Options and Risk
OTM options can expire worthless. The risk is limited to the premium paid, but the chance of full loss is higher than with ATM or ITM options.
Always size positions to handle this risk.
OTM in Option Strategies
OTM options are used in many strategies:
- Buying OTM calls or puts for cheap directional bets
- Selling OTM options to earn time decay (with caution)
- Iron condors using two OTM call and put spreads
- Strangles using OTM calls and puts together
Each strategy has its own risk profile.
OTM Options in Indian Markets
You can use OTM options on:
- Nifty and Bank Nifty weekly and monthly options
- Major F&O stocks
- Some sector indices where available
Watch liquidity, since deep OTM strikes can have wide spreads.
Example of an OTM Trade
Suppose you expect a big move in Bank Nifty around the RBI policy day. Bank Nifty trades at 47,000.
You buy a 47,500 OTM call at ₹80 and a 46,500 OTM put at ₹85.
If Bank Nifty moves sharply in either direction, one option can pay off well. If it stays in the middle, both can lose value.
This is a typical event-based strangle setup.
OTM Selling and Time Decay
Selling OTM options earns premium that decays into profit over time. The seller wins if the option expires worthless.
- The risk is large if the move goes against you
- Use spreads or stops to limit risk
- Track implied volatility, which affects option prices
OTM selling is popular with experienced traders.
Common Mistakes With OTM Options
New traders often:
- Buy too many cheap OTM lottery tickets
- Skip implied volatility analysis
- Hold OTM options too close to expiry
- Sell deep OTM options without proper risk control
A clear plan beats a hopeful bet.
Tips for Better Use
A few habits help:
- Match OTM strikes to your time frame
- Use small position sizes for OTM buying
- Check liquidity before entering
- Plan exits at clear targets or stop-losses
- Track implied volatility events
These habits help control risk while exploring the upside.
OTM Options vs ITM Options
OTM and ITM are opposites.
- OTM: cheap, low chance, high reward per unit
- ITM: expensive, high chance, lower reward per unit
Balanced traders use both based on the trade idea.
Key Takeaways
- OTM options have no intrinsic value yet
- OTM calls have strikes above the spot, OTM puts have strikes below
- They are cheap but need a strong move to profit
- Time decay hurts them fast near expiry
- Indian traders use OTM options on Nifty, Bank Nifty, and F&O stocks
OTM options can offer big payoffs but with limited odds. Use them with care, control your size, and let them play a small role in a wider plan.
