Moneyness (ITM, ATM, OTM)

Definition

Moneyness is options jargon for a simple question: *where does the strike price sit relative to the stock's current price?* Every option is in one of three states, and the labels — in-the-money, at-the-money, out-of-the-money — appear constantly in fund fact sheets, prospectuses, and monthly commentary. If you own a covered-call ETF, the fund's moneyness choice quietly shapes every distribution you receive.

The labels flip depending on whether the option is a call or a put, because "in the money" always means "worth something if exercised right now":

For a CALL (the right to BUY at the strike):

  In-the-money  (ITM)   strike BELOW the current price   (exercising is profitable)
  At-the-money  (ATM)   strike ≈ the current price
  Out-of-the-money (OTM) strike ABOVE the current price   (exercising makes no sense yet)

For a PUT (the right to SELL at the strike):

  In-the-money  (ITM)   strike ABOVE the current price
  At-the-money  (ATM)   strike ≈ the current price
  Out-of-the-money (OTM) strike BELOW the current price

So with a stock at $100, a $95 call is in-the-money (you could buy at $95 and the shares are worth $100), a $100 call is at-the-money, and a $105 call is out-of-the-money — it only becomes valuable to exercise if the stock climbs past $105.

Fund documents usually express moneyness as a percentage. When a covered-call fund says it writes calls "2-7% out-of-the-money," it means the strikes are set 2% to 7% *above* where the index is trading when the calls are sold. On a $100 index, a "5% OTM" call has a $105 strike. That one phrase tells you how much rally the fund has left itself room to keep before its upside is capped — the mechanics are covered in options basics.

Why It Matters

For an option *buyer*, moneyness is about the odds of a payoff. For income investors, the seat that matters is the call writer's — that is the seat every covered-call ETF sits in — and there, moneyness is the income-vs-upside dial. Where the fund sets the strike determines how the month's return splits between cash premium and potential price gain:

• At-the-money writing (strike ≈ price). This harvests the *maximum* time value the

market will pay, because an ATM option is where uncertainty — and therefore premium — peaks. The cost: the position keeps essentially zero upside. Any rally beyond the strike belongs to the option buyer from the first dollar.

• Out-of-the-money writing (strike above price, e.g. 2-7% OTM). The fund collects a

*smaller* premium but keeps the stock's gains up to the strike. A 5% OTM program keeps the first 5% of any rally each cycle before the cap bites.

• In-the-money writing (strike below price). Rare as a fund's core strategy. The big

premium looks tempting, but most of it is intrinsic value the writer gives straight back at settlement — the *true* earnings are only the small slice of time value, in exchange for surrendering all upside and pre-selling part of the position.

Turn the dial toward ATM and you get more income and less growth; turn it toward further OTM and you get less income and more growth. Neither setting is "better" — they are different answers to the same trade-off, which is why two covered-call funds on the *same index* can behave very differently. The dial-setting decision itself is the subject of strike selection.

Key takeaway: Moneyness is where the income comes from. An at-the-money program is a max-income, zero-upside machine; an out-of-the-money program deliberately accepts a smaller payout to leave some room for the market to run.

Intrinsic Value, Time Value, and Moneyness

Moneyness also determines what an option's premium is *made of*, and this composition is the difference between real income and an accounting illusion. Every premium splits into two parts (explained fully in option premium):

• Intrinsic value — how far the option is already in-the-money. A $95 call on a $100

stock has $5 of intrinsic value. OTM and ATM options have zero intrinsic value.

• Time value — everything above intrinsic; the price of the *chance* the stock moves

further before expiration. Time value is largest at-the-money and shrinks as the strike moves away from the current price in either direction.

Here is the part income investors must internalize: only time value is truly harvested by a call writer. Time value decays to zero by expiration, and that decay is the seller's earnings. Intrinsic value is not earnings at all — it is money the writer collects up front and then effectively hands back when the shares are called away below the market price. A fat ITM premium is mostly a refundable deposit, not income.

This is why "sell deeper in-the-money for bigger premiums" is a trap, and why serious covered-call funds describe their programs in terms of time value captured, not gross premium collected. It is also one reason a fund's distribution rate can overstate what the strategy genuinely earned in a given month.

Example

Suppose a stock trades at $100 and you can sell a one-month call at four different strikes. The premiums below are illustrative — real quotes move with volatility — but the *structure* is exactly what you would see in a live option chain. The final columns show what happens if the stock then rallies to $112 by expiration:

Walk through the arithmetic for one row. The $95 ITM call collects the biggest premium, $6.50 — but $5.00 of it is intrinsic value. At expiration the shares are called away at $95, a $5.00 loss versus the $100 starting price, which exactly cancels the intrinsic portion. The writer's real profit is the $1.50 of time value, the smallest in the table.

Now read the table top to bottom. As the strike moves from ITM to far OTM, the premium falls ($6.50 → $0.40), the time value peaks at-the-money ($3.00), and the upside kept in a rally grows ($0 → $10). In this rally scenario the further-OTM writer wins. In a *flat* month, the ranking reverses: the stock sits at $100, every call expires worthless, and the ATM writer keeps $3.00 while the 10% OTM writer keeps $0.40. Moneyness does not change how much total return exists — it changes which market environment pays you, a trade-off explored further in covered-call opportunity cost.

How Covered-Call Funds Set the Dial

Real funds sit at recognizably different points on the moneyness dial, and it explains much of the difference in their yields and their behavior in rallies:

• Funds that write at- or near-the-money on most of the portfolio maximize premium and

post the biggest distribution rates — and lag hardest when the index surges, because little or no upside was kept.

• Funds that write out-of-the-money — the "2-7% OTM" language you will see from funds

like SPYI and QQQI, which describe writing OTM index calls, sometimes on only part of the portfolio — accept a smaller premium to keep a slice of each rally, aiming for a middle path between income and growth.

• Funds like JEPI run the strategy through equity-linked

notes tied to slightly OTM index calls, pairing modest OTM writing with a lower-volatility stock basket.

The same fund can also move along the dial over time — some managers write closer to the money when volatility is rich and further out when it is not. When you compare two option-income funds, checking *where on the moneyness dial each one lives* (it is in the prospectus and monthly commentary) tells you more about future behavior than comparing headline yields. The covered-call ETF guide covers the other structural differences — underlying index, option type, and tax treatment.

Common Mistakes

• Judging a strategy by gross premium instead of time value. A deep ITM call's big

premium is mostly intrinsic value that gets handed back at assignment. Only the time value is genuinely earned — compare programs on that, not on the sticker premium.

• Reading "10% OTM" as "10% safer." Percent-OTM measures where the cap sits, not

downside protection. An OTM call writer still owns the stock and takes essentially the full loss in a selloff, cushioned only by the (small) premium collected.

• Assuming a higher distribution means a better fund. An ATM program will out-yield an

OTM program on the same index almost by definition. The extra yield was bought with the fund's upside, not created from nothing — check total return, not just the payout.

• Forgetting moneyness is a snapshot. An option written 5% OTM on Monday can be ITM by

Friday if the market rallies. Funds re-set strikes every cycle, so last month's dial setting is not a permanent property of the fund.

• Mixing up the call and put definitions. ITM means "below the price" for calls but

"above the price" for puts. Income funds are overwhelmingly *call* writers, so when a fund document says OTM, it almost always means strikes above the market.

FAQ

What does OTM mean?

OTM stands for out-of-the-money. For a call option, it means the strike price is *above* the stock's current price, so exercising the option would make no sense yet — the option has no intrinsic value, only time value. When a covered-call fund says it writes calls "5% OTM," it sets strikes 5% above the market, keeping the first 5% of any rally before its upside is capped in exchange for a smaller premium.

What is the difference between ITM, ATM, and OTM?

They describe where the strike sits relative to the current price. For a call: ITM (in-the-money) means the strike is below the price and the option already has intrinsic value; ATM (at-the-money) means the strike roughly equals the price; OTM (out-of-the-money) means the strike is above the price and the option is pure time value. For puts the ITM/OTM directions flip. The full mechanics are in options basics.

Why do at-the-money covered calls pay more?

Because time value — the part of the premium a seller actually earns — is largest at-the-money. An ATM strike is where the outcome is most uncertain, so buyers pay the most for the chance of a move. Move the strike OTM and the buyer's odds of a payoff shrink, so the premium shrinks with them. The catch is symmetrical: the ATM writer collects maximum income but keeps essentially none of a rally, while the OTM writer trades premium away for room to participate.

What happens when the stock passes the strike?

The call goes in-the-money and, at expiration, the writer is assigned: the shares are sold (called away) at the strike price. The writer keeps the strike-price proceeds plus the premium already collected, but every dollar of gain above the strike belongs to the option buyer. Inside a covered-call ETF this is routine — the fund settles or rolls the option and writes a new one — but it is exactly how the fund's upside gets capped in strong rallies.

Is it better to sell ITM, ATM, or OTM covered calls?

There is no universally better setting — it is a trade-off, and this article is educational, not advice. ATM writing maximizes income and gives up upside; modestly OTM writing (the common 2-7% range) takes less income and keeps some growth; deep ITM writing collects mostly intrinsic value that is returned at assignment, leaving only a small real profit. Which environment rewards each choice differs: flat markets favor ATM, rising markets favor OTM. Strike selection walks through the decision.

Does moneyness change after the option is sold?

Yes, constantly. Moneyness compares the *fixed* strike to the *moving* stock price, so an option written OTM can drift ITM as the market rallies, and vice versa. That is why fund behavior depends on the path the market takes during each option cycle, and why funds re-set their strikes every week or month when they write the next round of calls.