At-The-Money (ATM)

At-The-Money (ATM) (also known as 'On-The-Money') describes a scenario in the world of options trading where an option's strike price is identical, or very close, to the current market price of its underlying asset. Think of it as a financial standoff. If a stock is trading at exactly $50 per share, a call option or a put option with a strike price of $50 is considered 'at-the-money'. At this specific point, the option has no intrinsic value—meaning there’s no immediate, built-in profit from exercising it. Its entire value comes from its potential to become profitable before it expires, a concept known as extrinsic value or time value. It's like standing at a crossroads: the stock could go up, making a call option profitable, or down, making a put option profitable. An ATM option is perfectly balanced on this knife's edge, waiting for a push in either direction.

To fully grasp ATM, it's helpful to see it alongside its two companions: In-the-Money (ITM) and Out-of-the-Money (OTM). 'Moneyness' simply tells you whether an option would be profitable if you exercised it right now, ignoring the premium you paid for it.

• Bold: At-The-Money (ATM): The strike price is the same as the stock price. It’s a tie. The option has zero intrinsic value.
• Bold: In-The-Money (ITM): The option is already profitable to exercise.
  1. For a Call Option: The strike price is below the current stock price (e.g., you have the right to buy at $45 when the stock is $50).
  2. For a Put Option: The strike price is above the current stock price (e.g., you have the right to sell at $55 when the stock is $50).
• Bold: Out-of-the-Money (OTM): The option is not profitable to exercise.
  1. For a Call Option: The strike price is above the current stock price (e.g., you have the right to buy at $55 when the stock is $50).
  2. For a Put Option: The strike price is below the current stock price (e.g., you have the right to sell at $45 when the stock is $50).

While a true value investing purist focuses on buying great businesses at fair prices for the long term, understanding options can be a surprisingly useful tool and a source of valuable information.

ATM options are the most sensitive to changes in expected price swings, or volatility. The price of an ATM option (its premium) gives you a direct clue as to how much uncertainty the market is pricing into a stock's future. If the premium for an ATM option on a company you own suddenly skyrockets, it's a sign that traders are betting on a big move soon (perhaps around an earnings announcement). For a value investor, this can be a signal to double-check your thesis or simply be aware of the market's jittery sentiment.

Some value investors use a strategy called a covered call to generate extra income from stocks they already own and plan to hold for a long time. This involves selling a call option on your stock. Selling an ATM covered call often provides the most attractive premium, offering a nice balance between generating income and the risk of having your shares sold (or 'called away') if the price rises above the strike price.

The value of an ATM option is 100% extrinsic value (time value). This value behaves like a melting ice cube: it shrinks every single day as the option gets closer to its expiration date. This phenomenon is called time decay (or its Greek name, theta). The rate of this decay is fastest for ATM options. This is a double-edged sword:

• For the buyer, it's a constant headwind. You need the stock to move in your favor quickly enough to outrun the melting ice cube.
• For the seller, this decay is your best friend. If the stock price stays put, you profit as the option's value evaporates over time.

Let's put it all together.

1. Fictional Motors (ticker: FMI) is currently trading at $100 per share.
2. An ATM call option on FMI would have a strike price of $100.
3. An ATM put option on FMI would also have a strike price of $100.

If you buy the $100 call option, you are betting that FMI will rise significantly above $100 before the option expires. If you buy the $100 put option, you are betting it will fall significantly below $100. Right now, at $100, both options are on the fence, with their entire value derived from the possibility of a future price move and the time left for that move to happen.