Close to the money
Also written CTM · Close to the money (CTM) · CTM option
The band of option strikes clustered around the at-the-money strike which, in Options on Goods, lapse unless the buyer gives an explicit instruction to exercise them.
In plain language
Ordinarily an option that finishes in the money is exercised for you automatically. Close to the money is the exception, and it exists because of a very Indian problem.
The settlement price of an Option on Goods is not a traded price. It comes from polling — the exchange asks a panel of physical-market participants what the commodity fetched, and runs statistics over their answers. That is a sample, and samples carry error. A strike that the polled number says is in the money by a whisker might, on a different sample, have been out of it.
So for the strikes nearest that borderline, the exchange refuses to decide on the trader's behalf. Those are the CTM strikes, and they lapse unless the holder positively asks for them.
How it works
CTM is defined by counting strikes, not by measuring distance.
With an ATM strike: the ATM series, plus the three strikes immediately above and the three immediately below — seven strikes in all, of which three are in the money, one is at the money and three are out of it.
With no ATM strike — that is, when the Final Settlement Price falls exactly midway between two strikes — there is no at-the-money series at all. CTM is then the three strikes just above the FSP and the three just below: six strikes.
The exercise rules then fork three ways:
| Category | What happens at expiry |
|---|---|
| ITM, outside the CTM band | Exercised automatically, unless a contrary instruction is given |
| ATM and CTM | Lapse, unless an explicit instruction to exercise is given |
| OTM, outside the CTM band | Lapse worthless |
CTM applies only to Options on Goods. It does not exist for Options on Futures, where the settlement price is the daily settlement price of a real, exchange-traded futures contract and there is no sampling error to worry about. Section 4.2 also describes CTM loosely as strikes lying within about one to three ticks of the ATM; section 4.6 gives the operative definition, which is the count of three strikes either side.
A worked example
Gold, Options on Goods. On expiry day the polled spot Final Settlement Price comes in at Rs 49,900 per 10 grams. Strikes run from Rs 45,000 to Rs 55,000 at Rs 1,000 intervals. Lot size 1 kilogram.
| Strike | Call category | On expiry |
|---|---|---|
| 45,000 | ITM | Auto-exercised unless contrary instruction |
| 46,000 | ITM | Auto-exercised unless contrary instruction |
| 47,000 | CTM / ITM | Lapses unless explicitly exercised |
| 48,000 | CTM / ITM | Lapses unless explicitly exercised |
| 49,000 | CTM / ITM | Lapses unless explicitly exercised |
| 50,000 | CTM / ATM | Lapses unless explicitly exercised |
| 51,000 | CTM / OTM | Lapses unless explicitly exercised |
| 52,000 | CTM / OTM | Lapses unless explicitly exercised |
| 53,000 | CTM / OTM | Lapses unless explicitly exercised |
| 54,000 | OTM | Lapses worthless |
| 55,000 | OTM | Lapses worthless |
Now price the cost of silence. The Rs 49,000 call is in the money by Rs 900 per 10 grams:
Intrinsic value = 900 x 100 units of 10 g = Rs 90,000 per lot
It is also CTM. A holder who does nothing during the exercise window forfeits the entire Rs 90,000. The option does not pay him because it is in the money; it pays him because he asked.
Why NISM asks about it
Chapter 4 (Commodity Options), sections 4.2 and 4.6.1, and Chapter 4 section 4.6.2 on the exercise mechanism. This is one of the paper's favourite traps: expect "how many strikes are CTM" (seven, or six where there is no ATM), "CTM applies to which product" (Options on Goods only), and "ATM and CTM options are exercised on ____" (explicit instruction).
Common exam traps
- Seven strikes, not six — unless there is no ATM. The FSP landing exactly between two strikes removes the ATM series and leaves six.
- CTM does not exist for Options on Futures. Every ITM option on futures is auto-exercised subject only to a contrary instruction.
- ITM and CTM are opposite defaults. ITM is exercised unless you say no; CTM lapses unless you say yes. The two instructions even have different names — contrary and explicit.
- A CTM strike can be deeply valuable. Being close to the money is a position in the strike ladder, not a statement that the option is nearly worthless.
- The band is measured in strikes, not in rupees. Three strikes either side of ATM spans Rs 3,000 on a gold ladder with Rs 1,000 intervals and far less on a finer one.
- The reason for the band is polling sampling error, not volatility. A question that explains CTM by reference to volatility is wrong.
Check yourself
1.A buyer of an "Options on Goods" contract will end up having zero or close to zero cash flow on exercise if the option ends up as:
- a)Deep ITM options
- b)ATM or one of the 7 CTM strike options
- c)ATM or one of the 7 OTM strike options
- d)Deep OTM options
Show the answer
Answer: (b) ATM or one of the 7 CTM strike options
(This is a sample question from the NISM workbook.)
An ATM option "would lead to zero cash flow if it were exercised immediately", and CTM options are those "whose strike prices are very close to the spot price." So exercising either produces zero or nearly zero cash flow, before the premium.
Option (c) is the near-miss and the real trap. The seven CTM strikes are not seven OTM strikes — "there are 7 CTM Options: ONE OF WHICH IS ATM, 3 ARE ITM AND 3 ARE OTM." The band is deliberately built to straddle the spot price, three either side.
Option (a) deep ITM gives a large positive cash flow, which is precisely why ITM options are exercised automatically. Option (d) deep OTM would never be exercised at all — it expires worthless.
Why the CTM band exists at all is worth carrying into the exam: taking spot prices through a scientific polling process based on sample selection is highly manual and prone to sampling errors, so the seven-strike band lets traders having positions in border cases of sampling error make their judgement more diligently rather than being forced into delivery by a slightly mispolled price.
2.Spot market trade in commodities, particularly agricultural commodities, falls under the jurisdiction of:
- a)Individual state governments
- b)Central government
- c)Supreme court
- d)Local bodies such as municipalities and gram panchayats
Show the answer
Answer: (a) Individual state governments
(This is a sample question from the NISM workbook.)
Option (b) is the trap for anyone who assumes that because SEBI is a central regulator, its writ must cover everything it touches. It does not. SEBI governs the derivative, which is a security and therefore a Union subject; the physical sale of the same wheat in a mandi that morning is spot trade, a State subject, entirely outside SEBI's reach.
This one constitutional line explains a surprising amount of the syllabus:
- Spot markets sit outside SEBI, so exchanges must poll spot prices rather than read them off a screen
- Polling is "highly manual and prone to sampling errors", which is why Options on Goods carry a seven-strike CTM band
- Options on spot commodities were "very challenging" to implement and arrived only in 2020, while options on futures came in FY2017-18
- GST subsumes mandi tax but not mandi cess — a State levy on a State subject
Where this is taught
Free preparation for NISM Series XVIRelated terms
- Final Settlement PriceThe price at which a commodity derivative is finally settled at expiry — a simple average of the polled spot prices of the expiry day and the two days before it.
- MoneynessWhether exercising an option right now would give the buyer a positive, zero or negative cash flow — classifying it as in the money, at the money or out of the money.
- Contrary instructionAn instruction from the holder of an in-the-money option telling the exchange **not** to exercise it — the only way to stop an ITM contract being exercised automatically at expiry.
- Options on GoodsA European option whose exercise devolves directly into delivery of and payment for the physical commodity, rather than into a futures position.
- Spot price pollingThe statistical process by which an exchange collects physical-market prices from an empanelled panel of traders and users, strips out outliers, and publishes a single daily spot price.