If you are new to trading options, you might be wondering:
- What exactly is intrinsic value in options trading?
- How do I decide which option strike price to buy or sell?
- Why do some options cost more than others, even when they seem similar?
These are very common questions for anyone starting in the options market.
Understanding the intrinsic value of options and the concept of moneyness is the foundation for making smart decisions in option trading.
Whether you run a small online business selling handicrafts, a mobile repair shop, or a small manufacturing unit, knowing these basics can help you navigate the stock market better and protect your investments.
This guide will walk you through these concepts in simple terms, with practical examples that relate to everyday Indian business owners and traders.
What is Intrinsic Value in Options?
Intrinsic value refers to the real, immediate worth of an option if you were to exercise it right now. In other words, it’s the money you would make immediately if you decided to use your right to buy or sell the underlying asset today.
Key points to remember about intrinsic value:
- It is never negative; it can only be zero or a positive number.
- It tells you how “in the money” an option is — essentially, how profitable exercising it would be at the current market price.
- There are two types of options:
- Call option: The right to buy the underlying asset.
- Put option: The right to sell the underlying asset.
How to Calculate Intrinsic Value
- For Call Options: Intrinsic Value = Current Market Price (Spot Price) – Strike Price
(Only if this is positive; otherwise, the intrinsic value is zero.) - For Put Options: Intrinsic Value = Strike Price – Current Market Price (Spot Price)
(Only if this is positive; otherwise, the intrinsic value is zero.)
Example: Calculating Intrinsic Value of a Call Option
Imagine you are a freelancer and you are watching the Nifty index, which currently trades at ₹28,070. You buy a call option with a strike price of ₹28,050 (meaning you have the right to buy Nifty at ₹28,050). If you exercised the option today (expiry date), how much would you make?
Using the formula: Intrinsic Value = 28070 – 28050 = ₹20
This means you would earn ₹20 per unit if you exercised the option today (ignoring the premium paid to buy the option).
Why Can’t Intrinsic Value Be Negative?
Suppose you buy a call option with a strike price of ₹1920, but the current market price is ₹1918. Using the formula, you get:
Intrinsic Value = 1918 – 1920 = – ₹2 (which is negative).
If intrinsic value was allowed to be negative, exercising the option would mean losing more than the premium you paid, which contradicts the basic principle that the maximum loss for an option buyer is limited to the premium.
Therefore, negative intrinsic values are treated as zero to preserve this rule.
What is Moneyness in Options?
Moneyness describes how close an option is to being profitable based on the intrinsic value. It helps traders classify options into:
- In the Money (ITM): Options with a positive intrinsic value.
- At the Money (ATM): Options where the strike price is closest to the current market price.
- Out of the Money (OTM): Options with zero intrinsic value.
For practical trading decisions, moneyness helps you choose the right strike price according to market conditions.
Call Option Moneyness Explained
- If the strike price is below the current market price, the call option is In the Money (ITM).
- If the strike price is equal or closest to the current market price, it is At the Money (ATM).
- If the strike price is above the current market price, the call option is Out of the Money (OTM).
Example:
Current Index spot price: ₹18,060
- Strike 17,100 → ITM (₹960 intrinsic value)
- Strike 17,500 → ITM (₹560 intrinsic value)
- Strike 18,050 → ATM (closest strike to spot)
- Strike 18,100 → OTM (intrinsic value zero)
- Strike 18,300 → OTM (intrinsic value zero)
Put Option Moneyness Explained
For put options, the logic is reversed:
- Strike prices above the current market price are In the Money (ITM).
- Strike price closest to the market price is At the Money (ATM).
- Strike prices below the current market price are Out of the Money (OTM).
Example:
Current Nifty spot price: ₹18,202
- Strike 17,500 → OTM (intrinsic value zero)
- Strike 18,000 → OTM (intrinsic value zero)
- Strike 18,200 → ATM
- Strike 18,300 → ITM (₹100 intrinsic value)
- Strike 18,500 → ITM (₹300 intrinsic value)
Why Does Moneyness Matter to Indian Small Business Owners and Traders?
Understanding moneyness helps you:
- Choose the right option strike for your trading or hedging strategy.
- Estimate how much an option is likely to cost (premium).
- Understand risk and reward better. For example, ITM options cost more but are less risky, while OTM options are cheaper but riskier.
The Option Chain: Your Quick Reference Tool
An option chain is a list or table that shows all available option strikes for a particular underlying asset along with their prices, volumes, and moneyness.
For example, the option chain for a stock will show:
- Spot price (current market price)
- Calls on the left, puts on the right
- Strike prices in the middle, arranged in increasing order
- Options colored or shaded based on moneyness (ITM vs OTM)
This tool helps you quickly scan and pick options based on your strategy.
Watch the Premium Patterns
Premiums (prices you pay for options) tend to be higher for ITM options and lower for OTM options. This happens because ITM options have higher intrinsic value and thus more “real” worth.
Conclusion
Now that you understand the intrinsic value and moneyness of options, you have the tools to analyze options more clearly and pick strike prices that match your market outlook and risk appetite.
Just like a small bakery owner keeps track of costs and sales to price products right, you must understand these basics to price and trade options wisely.
