Table of Contents
Last updated on August 9th, 2022 at 02:12 am
*This post may contain affiliate links. As an Amazon Associate we earn from qualifying purchases.
When your options contract is out of the money, you may be stuck wondering what you should do with it. Should you wait till expiry or can you sell it?
You can sell options out of the money for a credit. Whether you should sell at the money or out of the money options depends on whether you want more premium or more potential upside.
If you believe the stock price will rise some then selling out of the money options is a good choice since you will get more potential upside this way. However if you think the stock will stay flat or go down slightly then it is better to sell at the money or even slightly in the money options to get the higher premiums.
The buyer of an out of the money option will pay you to take the options rights from you as they might expect the stock price to increase above the out of the money strike price.
Most option sellers will either sell at the money options (to get more premiums) or out of the money options (to get more potential upside). In the money options can be sold as well but that is more rare as the option seller will be giving up all of their potential upside and even some possible profit (although they are compensated for it by a higher premium.
In the rest of the article I will look at how you can sell options out of the money and how much you can expect to get from the transaction. You’ll also learn why other traders are open to buying out-of-the-money options.
How To Sell Options Out of the Money
If you’re holding an out-of-the-money call option contract, it means that the strike price is currently higher than the stock’s current price. For example, if the strike price is $50 and the stock price is currently $44, the option is out of the money.
For a put option, an out-of-the-money contract means the strike price is below the asset’s current price. For example, if the strike price is $40 for a stock trading at $44, the put option contract is out of the money.
In that situation, you can either choose to wait for the contract to go in the money and accumulate value or wait until the expiry date and lose the premium you’ve spent on it if the stock price doesn’t move where you want it to.
If you choose to sell the option while it’s out of the money, it’ll get taken off your hands by another buyer in return for (likely) a fraction of the amount you originally paid.
The total sum you’ll receive will depend on how far off the option is from the strike price. A stock trading at $34, when the strike price is $50, is out of the money by a lot. You’ll likely receive a very small sum for selling that option.
The further the distance between the strike and asset price, the smaller the sum you’ll receive for the contract. The logic is that the underlying stock is less likely to reach the distant strike price, so the buyer takes the risk on that premise.
The distance to the expiry date will also affect the cost of the contract.
You’ll receive more money if you sell an out-of-the-money contract that is further away from expiry than one that is closer.
Should You Sell Your Options Out of the Money?
You should sell your options out of the money if you’re convinced it’s the right decision. If there’s even the slightest possibility of the option going in the money, it may be worthwhile to hold back on selling until after the stock price moves.
Let’s say that you own 100 shares of ABC that currently trades at $50. If you believe it will rise to $55 in the next month but don’t see it going much higher then you could sell an out of the money call at a $55 strike price.
Let’s say you receive a $1 premium for selling that option. You just made $100 but you now are required to sell that stock at $55 on or before the expiration date.
Ideally the stock will move up near the $55 strike price but won’t go over it and the option will expire worthless. In that scenario you didn’t have to sell your stock and you also made that extra $100.
You could then sell the next month out option at the $55 strike or if you feel the stock will continue to rise you could sell a call option with a strike of $60 (again giving yourself more potential upside).
If you feel that a stock will gradually rise over time then selling a call option against the stock you own is a great way to make monthly income. However, if the stock has a meteoric rise you will miss out on any increase in the stock’s price above the strike price that you sold it at.
For most people, the buyer is your options broker. Some exchanges will match you up with other traders. In both instances, they’ll offer credit if you choose to sell the out-of-the-money contract.
You will get access to this option premium virtually immediately (one business day) and that premium is yours to keep no matter what happens with the stock price or the option contract.
If you’re selling your out-of-the-money options in this scenario, it’s important to weigh your decisions and make sure you’re doing the right thing—especially if you bought a handful of contracts.
Why Do Options Traders Buy Out of the Money Contracts?
Traders buy out-of-the-money contracts because they’re often very cheap and offer a high-profit potential if the contract goes in the money before or by the expiry date.
If a trader is confident that an underlying stock trading at $94 will rally to close above a strike price of $100 in the next few weeks, they’ll look for out of the money call contracts from other traders who don’t expect the rally to happen and want to sell their contract.
Such a contract might be priced at around $70 ($0.70 per share). The price is a bargain if you believe the stock will rise far above the strike price of $100. Basically that trader is paying .70 a share to get all the possible profits if the stock goes above $100.
By choosing to look for out-of-the-money options on sale, the trader can buy ten call contracts for the $700 (where they control 700 shares) whereas they could have only bought around 7 shares if purchasing the actual stock.
If the stock rises to $100.70 (strike price plus cost of premium per stock), the trader will break even. However, if it rises even further to $106, the profit on the position could be more than 750%.
So, traders are willing to buy out of the money options because it gives them extra leverage and allows them to stretch their money further.x However, you should remember that there’s a very high chance of such trades ending in a loss of the premium paid for each contract by the option buyer.
In the example above, the trader will need a 6.7% price move in the underlying stock before the option’s expiration date for the trade to end at breakeven. You’d need some catalyst to trigger the volatility required for such moves.
To make the 750% profit mentioned above, the price of that stock has to move 12% within that period.
You can sell options out of the money. Other traders will buy because it gives them extra leverage compared to in the money or at the money contracts. However, you need to weigh your options carefully to ensure that there’s a low risk of the contract going in the money before expiry.
Obviously you can’t know for sure but if a stock has bounced in a certain range for some time it is less likely to break out of that range to where you would have your shares called away from you.
If it goes in the money, you’d have lost a significant possible profit that you could have made by simply holding on to the stock.
However, no matter what happens with the option you get to keep the premium when you sell the option so that is a good way to make some extra income every month even if sometimes your shares will get called away.