Crypto option strike price guide: how to determine moneyness

With crypto options, the concepts of strike price and 'moneyness' play pivotal roles in determining the value and potential gains when trading crypto option contracts. For option traders interested in maximizing gains or effectively managing risk, understanding these terms is essential given the volatility involved with the crypto space.

This guide aims to break down the basics of strike price and moneyness so crypto option traders will be able to better evaluate options and make informed trading decisions. By covering what strike prices and moneyness mean, you'll be equipped to learn how to assess an option’s moneyness, and why these concepts matter, especially in the fast-paced world of crypto trading.

TL;DR

• Strike prices refer to the fixed price at which an option can be exercised.

• Moneyness is defined as the relationship between the strike price and the current market price.

• Intrinsic value reflects the immediate potential for gains of an option based on the difference between the strike price and the current market price, while extrinsic value shows the time value of an option, and is influenced by factors like time to expiration and implied volatility.

• Choosing the right options strike price depends on your overall risk tolerance, market outlook, and trading strategy.

• Moneyness isn't static, thanks to factors and catalysts like market volatility spikes and protocol upgrades.

What is a strike price in options?

The strike price is the fixed price at which the holder of an option can buy or sell the underlying asset. This price remains constant from the time the option contract is initiated until it expires, and effectively serves as the basis for assessing whether an option is lucrative.

In the context of crypto options, understanding the strike price is essential because it directly impacts whether an options trader is making gains or losses. For example, if a crypto options trader holds a call option with a strike price lower than the current market price of the asset to expiry, they stand to gain by buying at the lower price and selling at the higher market rate when the option expires.

Types of strike prices: ITM, ATM, and OTM

Strike prices in crypto options trading are often classified into three categories based on their relationship to the current market price of the underlying crypto asset.

1. In the Money (ITM): The option is favorable if exercised at the current market price.

2. At the Money (ATM): The strike price is equal to the asset’s current market price.

3. Out of the Money (OTM): The option isn’t favorable at the current market price and will be considered worthless at expiry.

These terms are central to determining the moneyness of an option, which we’ll explore in more detail below.

What is moneyness in crypto options?

Moneyness refers to the relationship between the strike price and the current market price of the asset. This concept helps crypto option traders determine whether exercising the option would lead to gains or losses. Moneyness can change as the market price fluctuates, which means an option can shift between being ITM, ATM, and OTM as market conditions evolve.

This is doubly so in the case of crypto options given how underlying crypto asset prices can be highly volatile. Similar to their TradFi option trader counterparts, crypto traders also use moneyness as an indicator to gauge the current value of their options and assess potential returns.

Moneyness categories explained

In the Money (ITM)

• Call options: The market price of the crypto asset is above the strike price. Exercising this option would result in gains because the crypto option trader can buy at the lower strike price and sell at the current higher market price.

• Put options: The market price of the crypto asset is below the strike price, making it lucrative for the trader to sell at the higher strike price.

At the Money (ATM)

• Call and put options: The strike price and the market price are roughly equal. ATM options are neutral in how lucrative they are and may hold value due to their potential to move ITM right before expiration.

Out of the Money (OTM)

• Call option: The market price is below the strike price, so exercising the call option wouldn’t be possible. The call option then expires worthless.

• Put option: The market price is above the strike price, meaning exercising the put option would be impossible as the put expires worthless.

Determining moneyness

Now that you're familiar with how strike prices relate to ITM, ATM, and OTM options, let's dive into the moneyness of crypto options and the key factors that determine their moneyness.

How to calculate moneyness

To assess moneyness, traders compare the current market price to the option’s strike price.

• For call options: If the current market price is more than the call option's strike price, the option is ITM.

• For put options: If the current market price is less than the put option's strike price, the option is considered ITM.

Here's an example. Suppose you have an ETH put option with a strike price of $3,000, and the current market price of the asset is $2,500. This call option is considered ITM as the asset price exceeds the strike price, offering the potential for gains if exercised.

Market factors that influence moneyness

As previously explained, moneyness isn't static. Rather, it’s influenced by the following factors.

1. Volatility: Higher price volatility can lead to sudden shifts in moneyness, making options more dynamic.

2. Time to expiration: As the option nears expiration, its chances of moving ITM essentially decrease based on the limited time remaining.

3. Market sentiment: Market news and sentiment can drive rapid changes in price, affecting the moneyness of crypto options. This plays into the concept of implied volatility (IV) and its rise ahead of a catalyst tends to impact the pricing of options.

How moneyness impacts the intrinsic and extrinsic value of an option

On a deeper level, moneyness and whether a crypto option contract is considered ITM affects its pricing in how the derivative's intrinsic and extrinsic values are determined.

Intrinsic value

Intrinsic value is the portion of an option's price that’s based on its immediate exercise value. It's the difference between the strike price of the option and the current market price of the underlying asset.

In the case of ITM options, they have positive intrinsic value, as they represent the immediate gains that can be realized by exercising the option. For example, a BTC call option with a strike price of $50,000 and an underlying asset price of $60,000 has an intrinsic value of $10,000. On the other hand, OTM options effectively have zero intrinsic value as there's no way of exercising them.

Extrinsic value

Also known as time value, extrinsic value represents the market's expectation of future price movement and the time remaining until the option's expiration. Factors affecting extrinsic value include the following.

• Time to expiration: When an option approaches expiration, extrinsic value falls as there's less time for significant price movements to occur. This ultimately causes the option's premium to fall over time as the option's expiration date nears and extrinsic value decreases.

• Implied volatility (IV): As mentioned earlier, IV is a measure of the market's expectation of future volatility of the underlying asset. Higher implied volatility generally leads to higher extrinsic value and option premiums as there's a greater chance of large price swings. This tends to be the case when there's a big upcoming catalyst that may cause price spikes.

The interplay between moneyness, intrinsic, and extrinsic value

• ITM options: As the underlying asset's price moves further in the money, the option's intrinsic value increases. However, time decay still erodes extrinsic value over time, even for ITM options.

• OTM options: The price of OTM options is primarily driven by extrinsic value. As time passes, their value severely declines due to time decay unless a significant increase in implied volatility occurs.

• ATM options: ATM options tend to have a balance of both intrinsic and extrinsic value. As the underlying asset's price moves closer to the strike price, the option's intrinsic value increases, while its extrinsic value decreases due to time decay.

Understanding the interplay between moneyness, intrinsic value, and extrinsic value is fundamental for effective option trading. By analyzing these factors, crypto options traders can make informed decisions about buying, selling, or holding option positions.

Choosing the right strike price for your option strategy

Choosing an option contract with the right strike price is a strategic decision influenced by factors like your trading goals, overall time frame, and general market outlook. As such, selecting a strike price that aligns with your risk tolerance and trading strategy can help you optimize your odds for success in the world of crypto options trading.

Practical tips for choosing option strike prices

Selecting the right strike price is a strategic decision influenced by your market outlook and risk tolerance. Here are a few tips to guide your choices.

• Bullish outlook: If you believe the underlying crypto asset’s price will rise significantly, consider an OTM call option. OTM options are cheaper in terms of premium, which means lower upfront costs for you. They can also yield greater gains if the price moves in your favor. However, they carry higher risk because they may expire worthless if the price doesn’t reach the strike price.

• Bearish outlook: If you anticipate a drop in the asset’s price, an OTM put option can be effective. It’s less expensive than an ITM option but offers substantial potential for gains if the asset’s price falls. As with OTM call options, this strategy comes with a higher risk of the option expiring worthless.

• Neutral outlook: If you expect minimal price movement, an ATM option may be suitable given that they have the potential to move ITM as expiration approaches. ATM options are often chosen for multi leg option strategies that aim to capitalize on volatility due to their sensitivity to price changes. As a result, they're often preferred by option traders who are more risk-averse.

• Taking into account IV: High IV can impact your strike price selection. For high-volatility scenarios, OTM options become more attractive as they have higher potential for moneyness shifts. Conversely, if IV is low, consider ITM or ATM options for their intrinsic value as OTM options may lack sufficient momentum to move ITM.

By factoring in your market outlook and IV, you can choose strike prices that align with your risk tolerance and trading goals.

Common strategies involving moneyness

Understanding how moneyness affects different options strategies can be crucial in optimizing your trades. Here are some popular strategies and how they take into account moneyness.

• Long call: Buying an ITM call option provides immediate intrinsic value but is more costly upfront. Though it carries higher risk, an OTM call option is cheaper and has the potential for more gains if the asset’s price rises.

• Long put: Similar to the long call, buying an ITM put option means higher upfront costs but intrinsic value protection. For more speculative positions, an OTM put can be chosen at a lower cost, although this carries a higher likelihood of expiring worthless if the asset’s price doesn’t drop.

• Straddles and strangles: In a straddle, both call and put options are purchased at the same ATM strike price to benefit from volatility regardless of direction. Choosing an ATM strike price balances the cost of both options and maximizes sensitivity to price changes in either direction. As for strangles, it involves buying a call and put at different OTM strike prices, betting on high volatility. Choosing OTM strikes lowers costs compared to a straddle, although it requires more significant price movement to yield gains.

Each strategy adopts moneyness to fit a particular market scenario, allowing traders to select strike prices that best align with anticipated movements and volatility.

Risk management and moneyness

Moneyness also plays a key role in risk management since different levels of moneyness affect both potential rewards and risks.

• ITM options for lower risk: ITM options are generally less risky than ATM or OTM options because they already contain intrinsic value. However, they cost more due to the immediate potential for gains if exercised. If risk management is your priority, ITM options may be the right choice, especially in highly volatile markets.

• OTM options for speculation: OTM options are cheaper and highly speculative. While they have no intrinsic value at purchase, they offer high leverage if the underlying asset’s price moves as anticipated. For this reason, they're riskier and suitable only for crypto option traders willing to accept the potential for total loss.

• ATM options for balanced risk and reward: ATM options offer a balance, combining moderate cost with some sensitivity to price movement in either direction. These options may be suitable for traders who want exposure to volatility without the extreme costs of ITM options or the high risk of OTM options.

By aligning moneyness with your risk tolerance, you can manage risk more effectively and make choices that suit your trading goals.

Examples of sudden shifts in moneyness

To further illustrate how moneyness can change, here are examples of real-world events that have influenced crypto options markets.

• Market volatility spikes: When significant news or events occur, such as regulatory announcements or macroeconomic shifts, crypto markets often experience volatility spikes. Suppose Microstrategy CEO Michael Saylor announces that he's willing to purchase more Bitcoin. The market price of BTC will likely surge, shifting the option to ITM and increasing its intrinsic value.

• Protocol upgrades: For tokens with upcoming protocol upgrades or major partnerships, prices can shift dramatically. If you hold an OTM Ether call option and an upcoming upgrade improves scalability, ETH’s price could rise, shifting the option closer to ATM or even ITM.

These scenarios illustrate how moneyness isn’t static and why crypto option traders must stay informed of potential catalysts that may alter their options' status.

Final words and next steps

Understanding strike prices and moneyness is fundamental for effective crypto options trading. The strike price serves as the reference point for potential gains, while moneyness helps determine whether an option is likely to be exercised with gains made. By carefully considering these elements, crypto option traders can make more informed decisions, aligning their trades with their financial goals and risk tolerance. As you deepen your understanding of options, these foundational concepts can serve as valuable tools in your trading journey.

Moneyness is deeply connected to option Greeks, which help traders quantify risk and make strategic decisions. Read our guide on option Greeks to learn more about concepts like time decay. Alternatively, you can also check out our guide on ITM vs OTM options to find out the differences between both types of options.