At the Money Example
Suppose that an investor purchases a call option for the stock of company A with a strike price of $75. If and when the market price of the shares of company A is 75$, the options that the investor purchased will be at the money.
Option Pricing and Intrinsic Value
Since an option represents a contract that can be exercised in the future, it has two sources of value: intrinsic value and time value.
Whether or not an option is at the money is a reference to the option’s intrinsic value, which is the value of the option were it to be exercised immediately.
This is in contrast to the time value of an option, which is a product of the possibility that the price of the underlying security becomes more favorable to the value of the option at some point over the option’s lifespan.
Therefore, an option that is currently at the money has no intrinsic value, as the option holder would merely be buying or selling the underlying security at the market price, which they could do directly in the market without the need to exercise the option.
At the Money Options and Trading
At the money options are important because they are often used as an entry point for hedging positions taken alongside larger position in the underlying security.
For example, if an investor opens a large long position in the shares of company A at $50 per share, they are also likely to buy put options with a $50 strike price as a hedge against a downturn in the share price from the point where they opened the position.
This is why at the money options are often the most traded strike price, as investors trade in heavy volumes as they continuously open (or close) positions at the current market price.
This means that day traders who trade in options can be assured of high liquidity for options that are currently at the money, as they look to capture short term price swings resulting from changes in the market price of the underlying security.
Many day traders who trade in options do so at the money or near the money, as they can capture quick yet substantial price changes in the high volume area of the underlying security’s option chain.
This is in direct contrast with out of the money options, which tend to have low volumes and whose prices change less often as a result.
Day traders are more likely to trade in at the money and near the money options, as these options will have the kind of trading volumes and price action that are supportive of traditional day trading strategies.
Much of the volume of at the money options is generated by investors taking hedging positions, which means that their options trades are the calculated product of a larger position.
This kind of formulaic trading is the ideal environment for smaller and more nimble day traders to profit from arbitrage and other similar day trading opportunities.