Out of the Money definition

When the underlying indicative index price of a market is below the strike price of a binary option, it is called out of the money. When the market price is above the strike price, it is in the money. When the price of the underlying market is exactly the same as the strike price, it is called at the money.

At expiration, the binary option must be in the money in order to give the full $100 payout. In other words, the market must be above the strike price. If the binary expires at the money or out of the money, the payout is zero.

The price of an option reflects intrinsic and extrinsic value. The option has intrinsic value if it is in the money. Thus, any time the market price is below the strike price, the option has no intrinsic value, only extrinsic value.

Extrinsic value is also called time value. It reflects the possibility that the market, even if it’s currently out of the money, could move up over time to become in the money. As the time remaining until expiration gets shorter, the option loses extrinsic value.

This makes intuitive sense. If an option has hours left until expiration, a lot could happen in that time and even a far out-of-the-money option could gain intrinsic value. If only a few minutes remain, the option will have little to no extrinsic value.

So if an option is out of the money with little time left until expiration, it is likely to have a low price, since it has very little extrinsic value and no intrinsic value.

This explains why options with strike prices high above the market are cheaper than lower strikes. Extrinsic value also explains why if two options have the same strike price, but one expires sooner than the other, the one with the earlier expiration will be cheaper. The option with more time remaining has more extrinsic value. 

See also In the Money

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