• Call Option: A call option is considered “out of the money” if the strike price is higher than the current market price of the underlying asset. In this scenario, exercising the option would not be profitable because the option holder would pay more to buy the asset than its current market value.
• Put Option: A put option is “out of the money” if the strike price is lower than the current market price of the underlying asset. Here, exercising the option would result in selling the asset for less than its current market value, which would also not be profitable.

Example:

• Call Option: If you hold a call option with a strike price of \$50, and the current market price of the stock is \$45, the option is OTM because you would be paying \$50 for something worth only \$45.
• Put Option: If you hold a put option with a strike price of \$50, and the current market price of the stock is \$55, the option is OTM because you would be selling at \$50 when you could sell at \$55 in the open market.

Importance:

• Intrinsic Value: An OTM option has no intrinsic value, only time value, which means its value is entirely based on the potential for the option to become “in the money” before expiration.
• Risk and Reward: OTM options are generally cheaper than in-the-money options, making them attractive for speculative strategies where investors expect significant price movements in the underlying asset. However, they also carry a higher risk, as they are more likely to expire worthless if the expected price movement does not occur.
• Trading Strategy: Traders might buy OTM options as part of a strategy that anticipates a strong move in the underlying asset’s price. While the probability of OTM options expiring worthless is higher, the potential reward if the option becomes ITM can be substantial.

OTM options are a key concept in options trading, representing a higher risk but also a potentially higher reward if the market moves in the trader’s favor.