What Is At The Money (ATM)?

At the money (ATM) is a situation where an option’s strike price is identical to the current market price of the underlying security. An ATM option has a delta of ±0.50, positive if it is a call, negative for a put.

Both call and put options can be simultaneously ATM. For example, if XYZ stock is trading at $75, then the XYZ 75 call option is ATM and so is the XYZ 75 put option. ATM options have no intrinsic value, but will still have extrinsic or time value prior to expiration, and may be contrasted with either in the money (ITM) or out of the money (OTM) options.

Understanding At The Money (ATM)

At the money (ATM), sometimes referred to as “on the money”, is one of three terms used to describe the relationship between an option’s strike price and the underlying security’s price, also called the option’s moneyness.

Options can be in the money (ITM), out of the money (OTM), or ATM. ITM means the option has intrinsic value and OTM means it doesn’t. Simply put, ATM options are not in a position to profit if exercised, but still have value—there is still time before they expire so they may yet end up ITM.

The intrinsic value for a call option is calculated by subtracting the strike price from the underlying security’s current price. The intrinsic value for a put option, on the other hand, is calculated by subtracting the underlying asset’s current price from its strike price.

A call option is ITM when the option’s strike price is less than the underlying security’s current price. Conversely, a put option is ITM when the option’s strike price is greater than the underlying security’s stock price. Meanwhile, a call option is OTM when its strike price is greater than the current underlying security’s price and a put option is OTM when its strike price is less than the underlying asset’s current price.

Special Considerations

Options that are ATM are often used by traders to construct spreads and combinations. Straddles, for instance, will typically involve buying (or selling) both an ATM call and put.

ATM options are the most sensitive to various risk factors, known as an option’s “Greeks”. ATM options have a ±0.50 delta, but have the greatest amount of gamma, meaning that as the underlying moves its delta will move away from ±0.50 rapidly, and most rapidly as time to expiration nears.

ATM options are the most sensitive to time decay, as represented by an option’s theta. Moreover, their prices are most responsive to changes in volatility, especially for farther maturities, and is expressed by an option’s vega. Finally, ATM options are also most sensitive to changes in interest rates, as measured by the rho.

At The Money (ATM) and Near The Money

The term “near the money” is sometimes used to describe an option that is within 50 cents of being ATM. For example, assume an investor purchases a call option with a strike price of $50.50 and the underlying stock price is trading at $50. In this case, the call option is said to be near the money.

In the above example, the option would be near the money if the underlying stock price was trading between about $49.50 and $50.50. Near the money and ATM options are attractive when traders expect a big movement. Options that are even further OTM may also see a jump when a swing is anticipated.

Options Pricing for At The Money (ATM) Options

An option’s price is made up of intrinsic and extrinsic value. Extrinsic value is sometimes called time value, but time is not the only factor to consider when trading options. Implied volatility also plays a significant role in options pricing. 

Similar to OTM options, ATM options only have extrinsic value because they possess no intrinsic value. For example, assume an investor purchases an ATM call option with a strike price of $25 for a price of 50 cents. The extrinsic value is equivalent to 50 cents and is largely affected by the passage of time and changes in implied volatility.

Assuming volatility and the price stay steady, the closer the option gets to expiry the less extrinsic value it has. If the price of the underlying moves above the strike price to $27, the option now has $2 of intrinsic value, plus whatever extrinsic value remains.

What Is the Arbitrage Pricing Theory (APT)?

Arbitrage pricing theory (APT) is a multi-factor asset pricing model based on the idea that an asset’s returns can be predicted using the linear relationship between the asset’s expected return and a number of macroeconomic variables that capture systematic risk. It is a useful tool for analyzing portfolios from a value investing perspective, in order to identify securities that may be temporarily mispriced.

The Formula for the Arbitrage Pricing Theory Model Is


$\begin{aligned} &\text{E(R)}_\text{i} = E(R)_z + (E(I) – E(R)_z) \times \beta_n\\ &\textbf{where:}\\ &\text{E(R)}_\text{i} = \text{Expected return on the asset}\\ &R_z = \text{Risk-free rate of return}\\ &\beta_n = \text{Sensitivity of the asset price to macroeconomic} \\ &\text{factor}\textit{ n}\\ &Ei = \text{Risk premium associated with factor}\textit{ i}\\ \end{aligned}$​E(R)i​=E(R)z​+(E(I)−E(R)z​)×βn​where:E(R)i​=Expected return on the assetRz​=Risk-free rate of returnβn​=Sensitivity of the asset price to macroeconomicfactor nEi=Risk premium associated with factor i​

The beta coefficients in the APT model are estimated by using linear regression. In general, historical securities returns are regressed on the factor to estimate its beta.

How the Arbitrage Pricing Theory Works

The arbitrage pricing theory was developed by the economist Stephen Ross in 1976, as an alternative to the capital asset pricing model (CAPM). Unlike the CAPM, which assume markets are perfectly efficient, APT assumes markets sometimes misprice securities, before the market eventually corrects and securities move back to fair value. Using APT, arbitrageurs hope to take advantage of any deviations from fair market value.

However, this is not a risk-free operation in the classic sense of arbitrage, because investors are assuming that the model is correct and making directional trades—rather than locking in risk-free profits.

Mathematical Model for the APT

While APT is more flexible than the CAPM, it is more complex. The CAPM only takes into account one factor—market risk—while the APT formula has multiple factors. And it takes a considerable amount of research to determine how sensitive a security is to various macroeconomic risks.

The factors as well as how many of them are used are subjective choices, which means investors will have varying results depending on their choice. However, four or five factors will usually explain most of a security’s return. (For more on the differences between the CAPM and APT, read more about how CAPM and arbitrage pricing theory differ.)

APT factors are the systematic risk that cannot be reduced by the diversification of an investment portfolio. The macroeconomic factors that have proven most reliable as price predictors include unexpected changes in inflation, gross national product (GNP), corporate bond spreads and shifts in the yield curve. Other commonly used factors are gross domestic product (GDP), commodities prices, market indices, and exchange rates.

Example of How Arbitrage Pricing Theory Is Used

For example, the following four factors have been identified as explaining a stock’s return and its sensitivity to each factor and the risk premium associated with each factor have been calculated:

• Gross domestic product (GDP) growth: ß = 0.6, RP = 4%
• Inflation rate: ß = 0.8, RP = 2%
• Gold prices: ß = -0.7, RP = 5%
• Standard and Poor’s 500 index return: ß = 1.3, RP = 9%
• The risk-free rate is 3%

Using the APT formula, the expected return is calculated as:

• Expected return = 3% + (0.6 x 4%) + (0.8 x 2%) + (-0.7 x 5%) + (1.3 x 9%) = 15.2%

What Is Arbitration?

Arbitration is a mechanism for resolving disputes between investors and brokers, or between brokers. It is overseen by the Financial Industry Regulatory Authority (FINRA), and the decisions are final and binding. Arbitration is distinct from mediation, in which parties negotiate to reach a voluntary settlement, and decisions are not binding unless all parties agree to them.

Arbitration is not the same as filing an investor complaint, in which an investor alleges wrongdoing on the part of a broker, but has no specific dispute with that broker, for which the investor seeks damages.

How Arbitration Works

In practical terms, arbitration is similar to a lawsuit but may be preferable for all parties due to the lower costs and time commitments involved.

When an investor or broker has a specific dispute with a broker that is registered with FINRA, they may file a claim with FINRA that states the alleged misconduct and the amount of money they are seeking in damages.

FINRA will appoint a panel of three financial industry professionals who, unless the injured party requests otherwise, will not be employed in the securities industry. This is intended to eliminate bias, but if one of the parties suspects that a member of the panel is biased, they may request a change.

Arbitration Hearings

For disputes involving less than $50,000, in-person hearings are not considered necessary; rather, both parties submit written materials to a single arbitrator who decides the case. For disputes ranging from $50,000 to $100,000, in-person hearings with a single arbitrator are the most common.

For disputes over $100,000, in-person hearings with three arbitrators are standard. A majority of the three-arbitrator panel (that is, two people) is necessary for a decision. Arbitrators are not required to explain their decision.

Parties filing for arbitration may represent themselves, or they may hire an attorney. In general, arbitration panels are less formalistic than the court system, so investors have a reasonable chance of being successful even when representing themselves.

Special Considerations

Arbitration panels do not necessarily award the full amount sought in a dispute. For example, if an investor files a claim against his or her broker for $38,000, the panel may decide in the investor’s favor, but only award $10,000.

Arbitration decisions are binding and not subject to appeal, except under very limited circumstances. FINRA’s mediation process, on the other hand, is not binding unless both parties agree to the settlement.

The Public Investors Arbitration Bar Association has criticized FINRA for lack of diversity on its arbitration panels and lax safeguards against bias and conflicts of interest. The regulator has argued that these criticisms are misplaced, particularly the focus on arbitrators’ age.

In their terms of service, most brokers require investors to agree to mandatory arbitration to settle potential disputes, rather than going to court. Since FINRA has a near-monopoly on arbitration, the organization’s panels are many investors’ only recourse.

What Is an Auction Market?

In an auction market, buyers enter competitive bids and sellers submit competitive offers at the same time. The price at which a stock trades represents the highest price that a buyer is willing to pay and the lowest price that a seller is willing to accept. Matching bids and offers are then paired together, and the orders are executed. The New York Stock Exchange (NYSE) is an example of an auction market.

Auction Market Process

The process involved in an auction market differs from the process in an over-the-counter (OTC) market. On the NYSE, for example, there are no direct negotiations between individual buyers and sellers, while negotiations occur in OTC trades. Most traditional auctions involve multiple potential buyers or bidders, but only a single seller, whereas auction markets for securities have multiple buyers and multiple sellers, all looking to make deals simultaneously.

Double Auction Markets

An auction market also known as a double auction market, allows buyers and sellers to submit prices they deem acceptable to a list. When a match between a buyer’s price and a seller’s asking price is found, the trade proceeds at that price. Trades without matches will not be executed.

Examples of the Auction Market Process

Imagine that four buyers want to buy a share of company XYZ and make the following bids: $10.00, $10.02, $10.03 and $10.06, respectively. Conversely, four sellers wish to sell shares of company XYZ, and these sellers submitted offers to sell their shares at the following prices: $10.06, $10.09, $10.12 and $10.13, respectively.

In this scenario, the individuals that made bids/offers for company XYZ at $10.06 will have their orders executed. All remaining orders will not immediately be executed, and the current price of company XYZ will be $10.06.

Treasury Auctions

The U.S. Treasury holds auctions to finance certain government financial activities. The Treasury auction is open to the public and various larger investment entities. These bids are submitted electronically and are divided into competing and noncompeting bids depending on the person or entity who places the recorded bid.

Noncompeting bids are addressed first because noncompetitive bidders are guaranteed to receive a predetermined amount of securities as a minimum and up to a maximum of $5 million. These are most commonly entered by individual investors or those representing small entities.

In competitive bidding, once the auction period closes, all of the incoming bids are reviewed to determine the winning price. Securities are sold to the competing bidders based on the amount listed within the bid. Once all of the securities have been sold, the remaining competing bidders will not receive any securities.