When pricing the intrinsic value of an option, it helps to understand an option’s moneyness. Moneyness is a term that relates the strike price of a derivative with the current market price of an underlying asset.
Moneyness is normally used to describe whether a put or a call option would be profitable should the holder of the option exercise it immediately. When assessing the value of an option, moneyness can tell us one of three things:
- is the option out of the money;
- is the option in the money; or
- is the option at the money.
If an option is in the money, it means that if the option is exercised right away, it will provide a profit opportunity immediately (provided the amount paid is less than the value captured), and the option is said to still have intrinsic value. This happens when a put’s strike price is higher than the current market price, or when a call’s price is below it.
Conversely, if an option is out of the money, it means that the option has no intrinsic value, since to exercise it would not return any profit. The option still has extrinsic value – sometimes called time value – relating to the option’s premium and the amount of time left before the option contract expires. An option is out of the money when a put’s strike price is lower than the present market price, or when a call’s is higher.
Finally, an option is at the money when an underlying asset’s current market price is precisely equal to that of the strike price of the option. As with an option that is out of the money, an option at the money has no intrinsic value as it would not yield a profit if it was exercised. However, the option does have extrinsic value which will be associated with variations in implied volatility and the time remaining on the option.
Although an option’s moneyness indicates its premium in the market, it’s also important to remember that options expire, but stocks don’t. And when they do expire, there are a number of different scenarios that play out depending on the status of the option at the time of its expiration date.
In general, if a stock expires out of the money there’s never any reason to exercise it as the option no longer has any intrinsic or extrinsic value. However, there are plenty of other situations to consider.
What Happens When A Put Option Expires In The Money?
If an investor owns a put option as well as shares in a stock, what happens when the put is in the money at expiration?
Simple, the shares will be automatically sold by the investor’s broker at the strike price.
If the investor does not own shares in the stock when the option expires, a short position will be initiated in the market instead.
The short will initiate at the strike price, and the investor will attempt to capitalize on the short by buying back the stock at a lower price. If they are concerned the stock will rise, they can close the short stock by buying back shares.
There are risks associated with holding a short position, particularly if the share price rises in the interim, and especially if the share price rises rapidly leading to a short-squeeze on the asset.
What Happens When A Call Option Expires In The Money?
An investor holding a call option which expires in the money will automatically have the stock purchased on their behalf at the strike price.
The investor can then sell those shares at the current market price of the underlying asset, which will be necessarily be higher than the strike price at which they were purchased.
If the amount of money profited by selling the shares is greater than the price paid for the call option, the call option buyer makes money.
A short call that expires in-the-money will result in assignment, and ultimately a short stock position. The seller of the call gets to keep the short call premium in that scenario.
Do You Lose Money If Options Expire?
If an investor buys an option as opposed to selling one, the only money they can lose at the expiration of the option is the money spent in purchasing the option. This would only happen if the option was out of the money. If the option is in the money, the investor can either sell or exercise the marketable option before expiration, thus locking in any gain acquired (minus the cost of the option purchased).
When a put option is in the money at the expiration date, the investor will be short the stock after it is automatically exercised. If the investor owns the stock and the option, the investor’s stock will instead be sold at the agreed strike price.
If a call option is in the money at expiration, the underlying asset will automatically be bought and placed in the investor’s account.
What Happens If You Sell An Option In The Money?
Selling an option functions as the reverse of owning one, and an investor who sells – or “writes” – an option will risk assignment if the option is in the money at expiration.
Option sellers have no control over assignment, and assignment can happen at any time either before or on the expiration date. Someone who buys an option, on the other hand, cannot be assigned stock except for when they exercise their option.
Writing an uncovered short call option risks having to sell an underling asset if the option is the money, and selling an uncovered short put option risks having to buy the stock at an agreed upon strike price. In general, the risks of selling an option increase as the option approaches its expiration date.
By combining stock ownership with the sale of a call, a more conservative and highly popular strategy – the covered call – can be initiated. In that case, 1 short call is sold for every 100 shares owned, on average.
Who Gets The Money When An Option Expires?
Options are a zero-sum game. Unlike stocks and shares, there’s always a winner and a loser on either side of an options contract. This doesn’t mean that the investor on the wrong end of an option is always worse off; options contracts are often made as a form of insurance or hedge against another pre-existing position in the market.
An investor that sells an option always gets to keep the option premium, but takes all the risk if the stock moves against them.
For instance, if a call or a put is in the money at expiration, the seller retains the premium, but has to pay the difference between the strike price and the asset price at the time of expiration.
An example would be if a seller sold a put option for $1 with a strike price of $100, and the asset dropped to $90 at the time of the option’s expiration date, the seller would keep the $1, but would have to purchase the asset for $100 when it was only worth $90. This would result in a net-net loss to the seller of $9.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.