An option is "out-of-the-money" when it has no intrinsic value based on the current stock price. An OTM option's entire premium is extrinsic value (also called time value), which decays away via Theta as expiration approaches.
OTM Put: A put is OTM when the current stock price is above the strike price. If the stock stays above the strike until expiration, the put expires worthless and the seller keeps the full premium.
OTM Call: A call is OTM when the current stock price is below the strike price. The call expires worthless if the stock never rises above the strike by expiration.
Why Wheel Traders Love OTM Options: Selling OTM options is the heart of the wheel strategy. The entire premium is extrinsic value that decays to zero via Theta if the stock stays on the right side of the strike. Wheel traders sell OTM puts hoping to keep the full premium, and OTM covered calls hoping to either keep the premium or sell their shares at a profit above their ACB.
Examples of Out-of-the-Money (OTM) in Action
- 1Selling a $95 put with the stock at $100 — the put is OTM by $5 and consists entirely of time value.
- 2A $110 covered call sold with the stock at $103 is $7 OTM — the seller profits if the stock stays below $110 at expiration.
- 3An OTM put with 20 DTE and $1.20 of premium — if the stock remains above the strike, the entire $120 is pure profit.