Near The Money Key Concept in Options Trading Explained
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The phrase "near the money" refers to an options contract whose strike price is close to the current market price of the corresponding underlying security. Near-the-money is synonymous with at-the-money. It is very seldom that the underlying asset's price will be exactly at the strike price.So, near-the-money is used and the strike price can be higher or lower than the market price. "Close to the money" is an alternative phrase, designating the same situation. It is very close to being "at the money"(ATM), but not quite the same.A call option is considered "in the money" (ITM) if its strike price is lower than the market price. However, if the strike price is higher than the market price, it would be "out of the money" (OTM). A put option's moneyness would work in opposite direction.Also, the option's premiums would need to be accounted for before it can be deemed to be in-the-money. Near the money is one of the states of option moneyness, along with in-the-money and out-of-the-money (OTM).
Core Description
- "Near the Money" (NTM) options are contracts with strike prices very close to the current market price of the underlying asset.
- NTM options have distinct risk and pricing characteristics, including high sensitivity (gamma, vega), concentrated time value, and pronounced response to changes in volatility.
- Their practical significance is evident in trading, hedging, and price discovery, where liquidity, cost efficiency, and responsive payoffs are important.
Definition and Background
"Near the Money" (NTM) refers to an option whose strike price lies very close to the current price of the underlying asset. Because the spot price and available strike prices rarely match exactly—due to set strike intervals—NTM is a practical market term for contracts within a narrow range of spot price. These options can be slightly in the money (ITM) or out of the money (OTM), but their defining feature is that the intrinsic value is near zero, with premiums mainly composed of extrinsic or time value.
Historical Evolution
The concept of NTM originates from early options trading. Before standardized exchanges, traders in markets such as Amsterdam and London preferred deals close to cash prices for practical reasons like execution and hedging. The emergence of listed options (such as the CBOE in 1973) set fixed strike ladders, and the requirement for contracts nearest to spot price—now called NTM—became clear for precision in pricing and risk management.
In the 1980s and 1990s, financial innovation highlighted the role of NTM options. Phenomena such as the volatility smile, surface modeling, and increased liquidity clustered near ATM/NTM strikes. Electronic trading has since intensified activity around the spot price, with market participants seeking these strikes for tight spreads, depth, and execution efficiency.
Calculation Methods and Applications
NTM options are identified by several commonly used financial metrics:
1. Price Proximity
A strike is deemed "near the money" if the absolute difference between the strike price (K) and the underlying price (S) is very small—generally within 1–2% of spot. For example, if a stock is trading at USD 100, and strikes of USD 99, USD 100, and USD 101 are available, all could be considered NTM.
2. Delta Approach
Delta quantifies the sensitivity of an option’s price to movements in the underlying. NTM options typically have deltas near ±0.50 (positive for calls, negative for puts), reflecting balanced reactivity to upward or downward moves.
3. Moneyness Ratios
Moneyness can be measured as S/K or K/S (spot-to-strike or strike-to-spot), which should be close to 1 for NTM options. Alternatively, log-moneyness, calculated as |ln(S/K)|， offers a normalized measure suitable across various assets.
Typical Calculation Example
Suppose the S&P 500 index stands at 4,500. With strikes set every 25 points, the 4,475, 4,500, and 4,525 strikes are all within a 1% band and thus are "near the money".
Applications in Trading and Risk Management
- Liquidity: NTM options often have the highest trading volume, ensuring tight bid-ask spreads and reliable pricing.
- Market Making: Dealers prefer NTM contracts for inventory management, as they have high gamma and vega.
- Implied Volatility Benchmarking: Major volatility indices (such as the VIX for US equities) are constructed from NTM option prices.
Comparison, Advantages, and Common Misconceptions
Comparison: NTM vs ATM, ITM, and OTM
| Aspect | Near the Money (NTM) | At the Money (ATM) | In the Money (ITM) | Out of the Money (OTM) |
|---|---|---|---|---|
| Strike | Very close to spot | Closest or equal to spot | Below spot (call) / above (put) | Above spot (call) / below (put) |
| Intrinsic Value | Nearly zero | Zero or almost zero | Positive | None |
| Time Value | Dominant | Dominant | Less than NTM | Highest as % of premium |
| Delta | ~±0.50 | ±0.50 | >0.5 (calls), <-0.5 (puts) | <0.5 (calls), >-0.5 (puts) |
| Gamma/Vega | Highest | Highest | Decreasing | Decreasing |
Advantages
- Balanced Exposure: NTM options provide high gamma (responsiveness to the underlying’s movement) with a more affordable premium compared to ITM contracts.
- Liquidity: The most active order books and the tightest bid-ask spreads typically exist at NTM strikes, facilitating efficient trade execution.
- Versatility: These options are suitable for directional views, hedging, and volatility-based strategies.
Disadvantages
- Rapid Time Decay: Theta, which measures time value erosion, is highest as expiration approaches, particularly if the underlying price remains stagnant.
- Volatility Sensitivity: Substantial drops in implied volatility, especially after major events, can quickly diminish premium value.
- Assignment Risk: When an option transitions to ITM, there is an increased risk of assignment or early exercise.
Common Misconceptions
Conflating NTM with ATM:
NTM is a range of strikes near spot price, not just the ATM strike.
Ignoring Premium in Profit Calculation:
Profitability is measured by breakeven (strike plus premium for calls, strike minus premium for puts), not simply by the underlying price exceeding the strike.
Misunderstanding Moneyness for Calls and Puts:
NTM classification depends on strike proximity to spot, but calls and puts react inversely to spot shifts—do not assume identical payoff scenarios.
Misinterpreting Delta:
A delta of approximately 0.5 does not indicate a 50 percent probability of finishing ITM. Delta describes sensitivity to small spot moves, not the end-of-term probability.
Practical Guide
Identifying Opportunities: Real-World and Virtual Case Study
Step 1: Define the Trade Objective
Suppose an investor expects a moderate, short-term increase in the share price of "ABC Corp," which is currently trading at USD 100. This expectation follows a positive earnings report scheduled in two weeks.
Step 2: Check Liquidity and Market Structure
Reviewing the options chain, strikes at USD 99, USD 100, and USD 101 show the highest open interest and tightest spreads, making them potentially favorable entry points.
Step 3: Assess Volatility and Risks
Implied volatility is elevated compared to its long-term average, reflecting event-driven risk. NTM premiums are relatively high.
Step 4: Choose Expiry and Strike
Selecting a monthly expiration date three days after the event, the investor chooses the USD 100 call option (NTM), which has a delta of 0.52, reflecting balanced price exposure.
Step 5: Analyze Breakeven and Sensitivities
- Option Premium: USD 2.50 per share
- Breakeven = USD 100 (strike) + USD 2.50 (premium) = USD 102.50
- Delta: 0.52, Gamma: 0.09, Vega: 0.14, Theta: -0.07
Step 6: Sizing and Order Placement
A limit order at USD 2.50 is used to help control the entry price and avoid slippage.
Step 7: Adjust and Hedge if Needed
If volatility decreases following the earnings report and the stock remains at USD 100, the premium diminishes swiftly (theta risk), and the investor may consider closing part of the position or rolling to a later expiry.
Step 8: Exit and Review
If ABC Corp rises to USD 104, the option accrues intrinsic value (USD 104 - USD 100 = USD 4), resulting in a USD 1.50 profit per share after accounting for the premium paid. If the stock remains flat, most of the premium erodes due to time decay.
Note: This scenario is hypothetical and provided for illustrative purposes. It does not constitute investment advice.
Best Practices for NTM Option Users
- Ensure substantial trading volume and open interest at the chosen NTM strike.
- Avoid holding positions into expiration unless you fully understand pin risk and assignment possibilities.
- Monitor Greek sensitivities—especially gamma, theta, and vega—as these can shift significantly over short periods.
Resources for Learning and Improvement
Foundational Books:
- Natenberg, S., Option Volatility and Pricing – Explores moneyness, Greeks, and volatility characteristics of NTM options.
- Hull, J., Options, Futures, and Other Derivatives – A comprehensive reference for option pricing and risk management, including clear ATM and NTM examples.
- McDonald, R., Derivatives Markets – Contains calculations and practice problems relating to moneyness and option valuation.
Academic Papers:
- Black, F. & Scholes, M., The Pricing of Options and Corporate Liabilities – Foundational model for ATM and NTM pricing.
- Merton, R., Theory of Rational Option Pricing.
Industry Materials:
- OCC, Characteristics and Risks of Standardized Options – Risk disclosure and product definitions.
- Cboe Options Institute – Offers educational materials and webinars on trading near-the-money options.
Online Courses:
- MIT OpenCourseWare, Finance Theory II – Options, Greeks, and strategy lectures.
- Coursera/edX: University-level finance and derivatives courses.
Analytics and Market Data:
- Exchange option chains with ATM/NTM filtering (Cboe, CME).
- QuantLib (open-source programming library), mibián/py_vollib for scenario analysis and modeling.
Broker Platforms:
- Modern brokers provide demo and simulated trading accounts; utilize these tools to practice NTM trades, analyze Greeks, and observe liquidity dynamics.
FAQs
What is “near the money” (NTM)?
NTM describes options with strike prices very close to the current price of the underlying asset. While not always exactly matching the spot price, NTM contracts display risk and price sensitivity similar to at-the-money options.
Is NTM the same as at-the-money (ATM)?
ATM is a specific term for the strike equal to the spot price. NTM refers to a group of strikes immediately above or below the spot when an exact match does not exist. Both share similar Greek characteristics.
How do calls and puts become NTM?
A call is NTM when the strike is just above or below the spot price. The same applies in reverse for puts. What matters is proximity to spot, not whether the contract is slightly ITM or OTM.
Why focus on NTM options?
NTM options generally exhibit the highest gamma and substantial vega, respond quickly to price changes, enjoy deep liquidity, and hold concentrated time value, making them relevant for trading and market-making.
Is there a fixed definition for “near”?
There is no rigid definition. Commonly, NTM includes any strike within 0.5–2.0% of the spot or within one standard interval on the option chain. Market convention and local liquidity are key considerations.
Which Greeks are most important for NTM options?
The most significant sensitivities for NTM are delta (near 0.50), gamma (rate of delta change, highest at NTM), and theta (time decay, largest absolute value).
How do volatility and skew behave at NTM strikes?
Volatility surfaces are generally benchmarked at ATM/NTM. Implied volatility is typically most stable here but may spike before major events due to increased demand for hedging or speculation.
Does the premium affect moneyness or trading outcomes?
Moneyness compares strike to spot. However, breakeven and profitability calculations depend on premium: For calls, spot must exceed strike plus premium; for puts, spot must fall below strike minus premium at expiry for profit.
Conclusion
"Near the Money" options play an important role in derivatives markets, offering traders, hedgers, and risk managers enhanced liquidity, cost-efficient exposure, and rapid response to changes in price and volatility. Understanding the unique characteristics of NTM options, as well as the differences between NTM and ATM, is essential for effective and risk-conscious options activity.
Mastering the selection, pricing, and management of NTM options allows market participants to access a vital segment of the options market, where activity and transparency are high. Ongoing learning, robust analytics, and disciplined strategy are crucial for realizing the practical benefits of NTM strategies across various asset classes and market conditions.
