Out- of- the- money options are purchasing a strike price that is away from the current cash or futures price.
For example, if the December Gold Futures price is at $800 per troy ounce, the December $900 call is out- of- the- money. Therefore, this call option contract has no intrinsic value, only time value reflecting its premium price.
The time value of an option contract shrinks as the expiration date approaches, with less and less time before it expires. On expiration date, if the underlying future price does not exceed the strike, the options can expire worthless. For example, if the December Gold Futures price is at $900, a December 900 call option would be worthless. The futures price did not exceed the strike price on expiration date. Therefore, the option contract has no time value remaining. However, option contracts can be sold before expiration date to preserve the time value remaining or to make a profit.
The objective and strategy behind purchasing options that are out- of- the- money is to pay a low premium, in other words, believing that premium is undervalued based on market fundamentals and then anticipating that future prices will have a sharp increase. Therefore, the premiums for option contracts increases, since the probability of the option contract attaining intrinsic value increases. In some cases, out- of- the- money options could be profitable before current cash or futures price reaches the strike prices as a result of probabilities.
If future prices decrease, trade sideways or market volatility declines, call option premiums can decrease, reflecting the likelihood that the option contract will not go in the money. As the expiration date approaches, the call option premiums could be rising slowly or not rising at all when the futures prices are rising because the likelihood is that the option contract will not go in the money.