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Key Takeaways
- A call is out of the money when its strike is above the stock price, while a put is out of the money when its strike is below the stock price.
- Out of the money options have zero intrinsic value, so their entire premium is extrinsic value.
- An out-of-the-money option can still gain or lose market value before expiration as price, time, and implied volatility change.
- A contract that remains out of the money at expiration becomes worthless and the buyer loses the full premium.
- Low dollar cost creates leverage, but it does not make a distant strike statistically or economically cheap.
What is an out-of-the-money (OTM) option?
An out-of-the-money (OTM) option is an option with zero intrinsic value because its strike sits beyond the current underlying price. A call is OTM when its strike is above the underlying, and a put is OTM when its strike is below the underlying. Its entire premium is extrinsic value, and its expiration payoff is zero if it finishes OTM.
With a stock at $100, the 105 call and the 95 put are both OTM. Their premium is entirely extrinsic value, reflecting time, implied volatility, rates, dividends, and distance to the strike.
How does an OTM option gain value?
An OTM option trades for a market premium before expiration. A move toward the strike raises the value of its directional exposure. Higher implied volatility raises the price of a standard long call or put with the other inputs held fixed.
A 105 call bought for $2.00 costs $200 with a 100 premium multiplier. Selling that call for $2.70 realizes $70 gross profit, including when the underlying remains below $105. Use the actual entry and exit premiums to calculate a closing trade’s result.
Time changes the remaining premium. For a contract that stays far OTM, both premium and the absolute size of daily theta approach zero near expiration under fixed price and volatility inputs. A contract approaching the strike develops a different gamma and theta profile. Compare the full price-and-time scenario before choosing the strike.
Worked Example
XYZ trades at $100. A trader buys one 105 call with 30 days to expiration for $2.00 per share, paying $200 for the standard contract. The call begins $5 out of the money with no intrinsic value.
- The call starts $5 OTM (105 strike versus $100 spot) with an expiration breakeven of $107 (105 strike plus $2.00 premium).
- At a $108 close the call finishes $3.00 in the money and is worth $300: ($108 − $105 − $2.00) × 100 = $100 profit.
- At a $106 close it finishes $1.00 in the money but is worth only $100, a $100 loss on the trade.
- At a $104 close it stays OTM and expires worthless, erasing the full $200 even though the stock rallied 4%.
Crossing the strike is necessary for expiration value but not sufficient to recover the premium. Before expiration the contract does not need to cross the strike at all: when XYZ jumps to $103 the next day and implied volatility lifts the call to $2.70 while it is still OTM, selling there books a $70 gain because the market now pays more for the remaining chance of reaching $105.
What is the expiration breakeven on an OTM option?
A purchased call’s expiration breakeven is strike plus premium. A purchased put’s is strike minus premium.
For the 105 call bought at $2.00:
- At $108 on expiration, the $300 payoff produces $100 gross profit.
- At $106, the $100 payoff leaves a $100 loss.
- At $104, the payoff is zero and the loss equals the $200 premium.
The call’s expiration breakeven is $107. Compare that level with the price target and time horizon of the setup.
How do traders use OTM options?
OTM calls provide upside exposure beyond a chosen strike. OTM puts provide downside exposure and portfolio protection below a chosen strike. Spreads, strangles, and iron condors use OTM legs to shape the position’s payoff and entry cost.
Read the complete structure. Compare the total premium, maximum option-payoff loss, breakevens, and target-price result. Then inspect bid-ask spread and available size to translate the plan into an execution price.
Options flow shows where activity concentrates by strike and expiration, and the options profit calculator compares the position across price, date, and volatility for the move you intend to trade.
Limitations of out-of-the-money options
- Size the position for a zero payoff. An option that finishes OTM pays nothing: the 105 call loses the full $200 at $104 even after a 4% rally in the stock.
- Target the breakeven, not the strike. At $106 the call finishes $1.00 in the money and still loses $100, because profit at expiration requires the stock to pass the $107 breakeven.
- A low dollar cost buys leverage. At the same expiration, more distant strikes carry lower deltas and lower modeled chances of finishing with value, so compare the breakeven with the move you expect.
- Give the move enough time and track implied volatility. The whole premium is extrinsic value, so time decay and a fall in implied volatility can erode it even when the stock moves the right way.
Bottom line
Out of the money means an option has no intrinsic value yet: its premium is all time, volatility, and distance to the strike. For a trade held to expiration, compare the target with the expiration breakeven. For an earlier exit, compare the expected sale premium with the entry cost. Size the position so the full premium is an acceptable loss, and judge the contract by its payoff and delta rather than by low cost.
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Sources and Further Reading
How entries are sourced, calculated and updated: editorial methodology.