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text courtesy of Wikipedia Creative Commons
Intrinsic value and time valueThe intrinsic value (or "monetary value") of an option is its value assuming it were exercised immediately. Thus if the current (spot) price of the underlying security (or commodity etc.) is above the agreed (strike) price, a call has positive intrinsic value (and is called "in the money"), while a put has zero intrinsic value (and is "out of the money").
The time value of an option is the total value of the option, less the intrinsic value. It partly arises from the uncertainty of future price movements of the underlying. A component of the time value also arises from the unwinding of the discount rate between now and the expiry date. In the case of a European option, the option cannot be exercised before the expiry date, so it is possible for the time value to be negative; for an American option if the time value is ever negative, you exercise it (ignoring special circumstances such as the security going ex dividend): this yields a boundary condition.
[edit] ATM: At the moneyAn option is at the money if the strike price is the same as the current spot price of the underlying security. An at the money option has no intrinsic value, only time value.[1]
1.^ At the Money Definition, Cash Bauer 2012
[edit] ITM: In the moneyAn in the money option has positive intrinsic value as well as time value. A call option is in the money when the strike price is below the spot price. A put option is in the money when the strike price is above the spot price.
OTM: Out of the moneyAn out of the money option has no intrinsic value. A call option is out of the money when the strike price is above the spot price of the underlying security. A put option is out of the money when the strike price is below the spot price.
