Options are all about where you sit relative to the price – in, out, or somewhere in between. In this chapter we break down what those labels actually mean, and why understanding intrinsic value and time value is the key to using them properly.
Grab a drink and let’s go over the new jargon from Chapter 5. People love to make this stuff sound complicated, but it’s really not.
American Options: Options you can exercise any time before the expiry date. Most U.S. stock options are American, but nobody actually exercises early because you’d just throw away the time value you paid for.
Ask: The price a seller is demanding.
ATM (At The Money): An option where the strike price is exactly the same, or practically the same, as the current stock price.
Bid: The price a buyer is actually willing to pay.
Breakeven: The magical price where you neither make nor lose money. For a call option, just add your strike price to the premium you paid.
DITM (Deep In The Money): The bread and butter of our strategy. This means the strike price is well below the current stock price. They move almost point-for-point with the stock itself, giving you all the leverage with half the capital.
European Options: Options that strictly lock you out until the actual expiry day.
Exercising: Acting on your right to actually buy the underlying asset at your strike price.
Intrinsic Value: The real, actual value of an option. It is the difference between your strike price and the current price, representing what you would get if you exercised right this second.
ITM (In The Money): An option with a strike price below the current stock price.
ITM Strategy: Embarrassingly simple. We buy DITM options with little to no time value, and we hold them until we get an OUT signal or are nearing 30 days to expiry.
Open Interest (OI): The total number of options sitting around at a specific strike price.
Options Chain: The master table listing every strike and expiry for a stock, along with the bids and asks.
OTM (Out of The Money): A strike price above the current stock price. They are cheap because they consist of pure time value and zero intrinsic value. They are basically lottery tickets.
Spread: The gap between the bid and the ask. You want this to be small so you don’t get robbed on the execution price.
Temporary Trader: The graveyard of greedy traders who try to get rich quick by buying cheap, short-dated OTM options. They inevitably blow up their accounts when the market turns, and they quit bitter.
Time Value: The premium you pay for “hope”. It’s the extra cash you throw down hoping the stock moves your way before the clock runs out. At expiry, this value vanishes completely.
Volume: The number of contracts that were traded today.
Witching Hour: The frantic last hour of trading on the third Friday of the month when options expire. Traders scramble to close or roll their positions before the closing bell.
Out & In The Money
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Please note that Heather answers all questions at the end of the ITM Blog.
Happy trading!
