Out-of-the-money

An out-of-the-money option is one you would not exercise today. A call struck at 17,600 when the index is at 17,562 gives you the right to buy at a price worse than the market. You would not use it, so you would not pay for that right — you pay only for the chance that the index gets above 17,600 before the contract dies.

That is why an OTM option is cheap, and why it is the option most likely to expire worthless. It has zero intrinsic value; its entire premium is time-value, and time value is the one component of an option price that is guaranteed to fall to zero.

Cheap and likely to die is not a contradiction. It is the entire proposition.

Because an OTM option costs less, the same rupee buys more of them, and the percentage return on a correct call is larger. The workbook makes this point with numbers rather than words, and it cuts both ways:

• On a big move, the deep OTM option wins on return on investment, because the denominator is tiny.
• On a small move, the deep OTM option loses everything, because the move never reaches the strike.

The seller's side is the mirror. Writing deep OTM options is the low-risk, low-premium corner of the board; writing deep in-the-money options fetches a fat premium and carries the larger risk. The workbook states this directly for puts: selling deep ITM puts fetches higher premiums and carries higher risk, while selling deep OTM puts is less risky with lower premium.

One detail that catches candidates: the moneyness label travels with the contract type, not the strike. At a spot of 17,562 the 17,300 call is deep ITM while the 17,300 put is OTM — same strike, opposite labels.

Call is OTM when Spot < Strike
Put  is OTM when Spot > Strike

Intrinsic value of an OTM option = 0
Premium of an OTM option         = Time value, in full

ROI on an option = Net profit ÷ Premium paid

The index is at 17,562. Four puts are listed, with a contract size of 50:

The index falls to 17,000 on expiry. Every put is now in the money. The profits, per unit:

17,300 put:  17,300 − 17,000 − 65  = Rs 235    ROI = 235 ÷ 65  = 362%
17,400 put:  17,400 − 17,000 − 91  = Rs 309    ROI = 309 ÷ 91  = 340%
17,500 put:  17,500 − 17,000 − 121 = Rs 379    ROI = 379 ÷ 121 = 313%
17,600 put:  17,600 − 17,000 − 167 = Rs 433    ROI = 433 ÷ 167 = 259%

The deepest OTM put made the least money and the highest return. In rupees on one lot: Rs 11,750 on the 17,300 put against Rs 21,650 on the 17,600 put. In percentage terms: 362% against 259%.

Now stop the fall at 17,450 instead. The 17,300 put expires worthless — the full Rs 3,250 is gone. The 17,600 put is worth Rs 150 a unit, Rs 7,500 a lot, against Rs 8,350 paid: a loss of Rs 850, about 10%.

Same view, same direction, right on both counts — and the OTM buyer lost 100% while the ITM buyer lost 10%. OTM options do not reward being right about direction. They reward being right about magnitude.

Chapter 16.3 defines OTM, and Chapter 16.10 (Analysis of options from the perspectives of buyer and seller) runs the full ROI tables for both calls and puts — the 362%/340%/313%/259% ladder above is the workbook's own. Expect a classification question, and an ROI comparison question whose answer is that the deep OTM option gives the highest return on investment when the underlying moves sharply.

• "Higher ROI" is not "higher profit". The workbook's own table shows the deep OTM put earning the smallest rupee profit and the largest percentage return in the same scenario.
• An OTM option has zero intrinsic value, not negative. Intrinsic value has a floor of zero because nobody exercises into a loss.
• The same strike is OTM for one contract type and ITM for the other. Read the type before the number.
• OTM is not the same as worthless. It trades at a positive premium right up to expiry because time value is positive while time remains.
• For the writer, deep OTM is the low-risk corner, not the high-risk one — low premium, low probability of assignment. Candidates often invert this.
• Break-even is further away than the strike. An OTM call only starts paying above strike plus premium, which is why break-even-point and moneyness are different questions.