Options contracts give the holder the right to buy or sell an
underlying security at a predeterminedstrike price for a limited
amount of time. If the underlying security is trading at the same
price as the strike price of theoptions contract then theoption is
said to be trading "at the money ."
In general, the price of an option is determined by the
relationship of the strike price to the price of the underlying
security, thetime value of the contract, and the volatility of the
underlying security. When an option is at the money, the first of
those pricing factorswill be equal to zero.
How Traders Use It
If an option is trading at the money, traders will be able to buy
or sell the options contract priced solely on the time and
volatility factors. Because of that, anat-the-money option can
provide a great deal of information to an investor. If an option is
not trading at the money, its price will include a cost for
theintrinsic value of the relationship between themarket price and
the strike price, in addition to time and volatility values.
As an overly-simplified example, consider an option on
Google (Nasdaq: GOOG)
that has 30 days remaining untilexpiration and is trading at the
money. Assume that the option is quoted at $10 a share.
For 30 days, the trader knows that the interest rate is about
0.01%, and given such a low value can assume that the time value of
this option is worthless. That means the $10 reflects only the
price for volatility in the underlyingstock .
A price of $10 indicates that traders think it is very likely
that Google will move at least that much over the next month and on
an annualizedbasis , this would be equal to about 20% volatility in
the stock. Knowing a value for volatility, traders can then find
fair prices for other options available on Google.
In reality, the time value would not be precisely zero and the
quoted price of the options contract will include other factors, so
this example should be viewed as an oversimplified generalization
used for illustrative purposes only.
Why It Matters To Traders
Anat-the-money option will allow traders to get an estimate of how
themarket is valuing the other factors in the options pricing
equation. The price of at-the-money options will reflect only the
factors associated with the time value and the volatility of the
Action to Take -->
This presents a simplified approach for traders to determine the
market factor for volatility of any underlying security without
having access to historic options data and advanced mathematical
This article originally appeared on ProfitableTrading.com:
Options 101: At the Money