Near the Money: Understanding Options Contracts and Strike Prices

A comprehensive guide to understanding the concept of 'Near the Money' in options trading, including how it works, its importance, and practical examples.

“Near the Money” is a term used in options trading to describe an options contract whose strike price is close to the current market price of the underlying security. This concept is crucial for traders aiming to optimize their strategies in the options market.

Definition and Key Concepts

Near the Money (NTM) options are those where the strike price is very close to the current market price of the underlying asset. This proximity impacts the intrinsic and extrinsic value of the option, influencing trading decisions and strategies.

$$ \text{If} \ | \text{Strike Price} - \text{Market Price} | \ \leq \ \Delta, \ \text{then the option is considered 'Near the Money'.} $$

Here, \( \Delta \) represents a small value range that traders or analysts define based on their market or trading parameters.

Importance in Trading

NTM options are significant for multiple reasons:

• Liquidity: NTM options typically have higher trading volumes, making them more liquid.
• Volatility: They are more sensitive to market movements, offering higher potential returns but also higher risks.
• Premium Cost: These options generally have moderate premiums compared to deep in-the-money (ITM) or out-of-the-money (OTM) options.

Examples

Consider a stock currently trading at $100:

• An NTM call option might have a strike price of $101.
• An NTM put option could have a strike price of $99.

Historical Context

The concept of NTM has evolved with the sophistication of financial markets. Originally, options trading primarily focused on ITM and OTM options, but the introduction of more advanced trading algorithms and strategies increased the popularity of NTM options.

Practical Application

Investors use NTM options in various strategies:

• Hedging: Protecting against small adverse movements in the underlying asset’s price.
• Speculation: Betting on slight price movements to capitalize on the higher gamma of NTM options.
• Spread Strategies: Using NTM options in complex spread strategies to balance risk and reward.

Comparisons with Related Terms

• In the Money (ITM): Options with intrinsic value (strike price below the market price for calls; above for puts).
• Out of the Money (OTM): Options with no intrinsic value (strike price above the market price for calls; below for puts).

FAQs

Why are NTM options popular among traders?

NTM options offer a balanced mix of risk and potential reward, making them attractive for both speculative and conservative strategies.

How does the premium of an NTM option compare to ITM and OTM options?

NTM options usually have higher premiums than OTM options but lower than ITM options due to their balanced risk-reward profile.

Can NTM options become ITM or OTM?

Yes, depending on the price movements of the underlying asset, NTM options can shift to ITM or OTM.

References

1. Hull, John C. “Options, Futures, and Other Derivatives.” Pearson, 2018.
2. Black, Fischer, and Myron Scholes. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 1973.

Summary

“Near the Money” options play a vital role in modern trading strategies, providing traders with opportunities to leverage their positions with balanced risk and reward. Understanding and utilizing NTM options can be crucial for both novice and experienced traders in achieving their financial goals.