Editor’s Note: In the caffeine-fueled world of options trading, choosing the wrong strike price can feel like bringing a kazoo to a gunfight.

Traders love to pretend they’ve evolved past the basics, but the truth is, even veteran investors occasionally confuse intrinsic value with their own self-worth. So here’s your no-nonsense, jargon-light refresher on one of the most consequential decisions in options: ITM or OTM? If you’re asking, “How hard can it be?”—you probably need to read this article twice.

Let’s Start With the Basics (No, You’re Not Above This)

For options traders, few decisions are as pivotal, or as deceptively simple, as choosing the right strike price. The wrong choice? You’re holding a worthless piece of paper. The right one? You’re printing money.

Understanding the difference between in-the-money (ITM) and out-of-the-money (OTM) options is essential whether you’re a rookie with a Robinhood account or a battle-hardened veteran selling premium from a hammock in Boca.

An ITM call option has a strike price below the market price. An OTM call? Its strike is above the market price.
Flip it for puts: an ITM put strike is above the market price, and an OTM put strike is below.

Say XYZ stock is trading at $15.50. A call option with a $14 strike is ITM. A call with a $17 strike is OTM. Meanwhile, a $17 strike put is ITM, while a $14 strike put is OTM. Crystal clear, right?

Here’s the key difference: You would only ever exercise an ITM option, because it lets you buy or sell at a better price than the market offers. If an option is OTM, it would be financial lunacy to exercise it. Why buy shares at $17 when you could just buy them in the open market for $15.50?

Intrinsic Value vs. Time Value: A Love Story That Ends in Decay

An ITM option has something called intrinsic value—this is the real, tangible value it would generate if exercised today. In our XYZ example, the $14 call is worth $1.50 in intrinsic value ($15.50 market price minus $14 strike).

OTM options, on the other hand, have zero intrinsic value. They’re all about potential—more dream than reality.

But wait, there’s more! An option’s price also includes time value, i.e. how much someone is willing to pay for the possibility that the option might become profitable before it expires. Time value shrinks every day. This withering process is called theta, and it’s the enemy of every OTM option holder hoping for a miracle.

Theta is a negative number that tells you how much value your option loses each day even if the stock price doesn’t move. It’s like a melting ice cube with a timer. On expiration day, time value hits zero. If your OTM option is still out-of-the-money, it expires worthless—and you’re left with nothing but a lesson.

ITM vs. OTM: Risk, Reward, and Reality

Buying an OTM option is like betting on a long shot: low upfront cost, potentially huge percentage gains, but the odds are stacked against you. You’re paying only for time value and hope. If the underlying stock doesn’t move in your favor, fast enough and far enough, you’re toast.

By contrast, ITM options are more conservative. They already have intrinsic value, so you’re not starting from zero. That means even if the stock doesn’t move much, you might still walk away with something. But this safety comes at a price: ITM options are more expensive, and because of that, it takes a bigger absolute gain to hit the same percentage return as an OTM gamble.

Let’s say you buy an OTM option for $1. If it climbs to $1.50, you’re up 50%. Nice. But if you bought an ITM option for $5, you’d need it to jump to $7.50 to hit the same percentage return. That’s a steeper hill.

Which Should You Pick?

If you crave moonshot returns and don’t mind the high probability of losing it all, OTM options might be your game. They’re cheaper, and if you time it right, the gains can be explosive. But don’t forget the odds: most OTM options expire worthless.

If you prefer a steadier, less stressful ride, and are okay with smaller (but more likely) gains, ITM options are the safer bet. You’re paying more, but you’re buying actual value, not just potential.

Ultimately, it’s about risk tolerance, strategy, and the kind of trader you want to be. Just remember: in options trading, cheap isn’t always good, and expensive isn’t always bad. What matters is what you actually expect the stock to do, and whether your strike price puts you in position to capitalize.

In the game of options, the strike price is your sword. Pick it wisely, and you just might slay the market. Pick wrong, and you’ll be left holding an expensive reminder that in trading, hope is not a strategy.

Jim Fink is the chief investment strategist of several premium trading services, including Velocity Trader, Options for Income, and Jim Fink’s Inner Circle.