What Does "near the Money" Mean?
"Near the money" is a term used when trading options to describe an option whose underlying stock has a price very near the strike price of the option. Since the strike price is the price at which the option may be exercised by the contract holder, options that are near the money will usually cost an investor more to purchase them. These options may be either "in the money," which means the underlying stock price has already exceeded the strike price, or "out of the money," which means that the price has not yet reached the strike price. In either case, options of this type have excess value due to the likelihood that they will go into the money before the contract expires.
Options contracts are transactions known as derivatives, since they derive their value from some underlying security. There are call options, which allows the contract-holder the right to purchase shares of an underlying security such as stock shares, and put options, which bestow the right to sell the underlying stock. The key is that the stock price must reach a predetermined price known as a strike price before the option may be exercised. Near the money options are already very close to reaching the strike price threshold.
As an example, imagine that an investor purchases a call options contract on shares of a stock that is currently trading at $20 US Dollars (USD) per share. The options contract comes with a strike price of $20.30 USD. This option is near the money, since the proximity of the strike price and current market price is so close.
There are two types of value that an options contract can have. All options have time value, which is based on the potential for the underlying stock price to move in the desired direction. An in the money stock has intrinsic value as well, since it can be exercised by the holder. When an option is near the money, it has the potential for both types of value, which makes it valuable.
For that reason, a near the money stock option comes with a premium price that is higher than options with a great distance between strike and current price for the underlying stock. Those latter options possess a great risk of never reaching the strike price, thereby rendering them worthless. Option sellers generally adjust the premium they demand for the contract based on how close to the money a contract may be.
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