When trading options spreads, one of the most important decisions you will make is where to place your strikes. Should you trade at-the-money (ATM) spreads or out-of-the-money (OTM) spreads? Each approach has distinct advantages and trade-offs that can significantly impact your results.
Understanding ATM and OTM Spreads
Before diving into the comparison, let us define these terms clearly:
ATM (At-the-Money) Spread: A spread where the short strike is at or very close to the current stock price. These spreads have roughly a 50% probability of profit.
OTM (Out-of-the-Money) Spread: A spread where the short strike is away from the current stock price. For credit spreads, OTM means the short strike is unlikely to be reached based on current prices.
ATM Spreads: Higher Premium, Higher Risk
At-the-money spreads offer the highest premium because the options have the most extrinsic value. However, they also carry more risk because the stock only needs to move slightly against you to put the spread in the money.
Advantages of ATM Spreads
- Maximum premium collection: ATM options have the most time value, so you collect more credit
- Better risk/reward ratio: The higher premium means better return on risk
- Faster theta decay: ATM options decay fastest as expiration approaches
- More responsive to adjustments: Easier to roll or adjust when needed
Disadvantages of ATM Spreads
- Lower probability of profit: Roughly 50% chance of success
- More sensitive to price movement: Small moves can quickly put you in trouble
- Higher delta exposure: Your position is more directional
- Requires more active management: You need to watch these closely
Example: ATM Put Credit Spread
Stock XYZ is trading at $100. You sell an ATM put credit spread:
- Sell the $100 put for $4.00
- Buy the $95 put for $2.00
- Net credit: $2.00 ($200 per contract)
- Max loss: $3.00 ($300 per contract)
- Probability of profit: ~50%
OTM Spreads: Lower Premium, Higher Win Rate
Out-of-the-money spreads collect less premium but have a higher probability of expiring worthless. The stock has to move significantly against you for these spreads to lose money.
Advantages of OTM Spreads
- Higher probability of profit: Typically 65-85% depending on how far OTM
- More forgiving: The stock can move against you and you still win
- Lower delta: Less sensitive to small price movements
- Less stressful: Easier to hold through normal market fluctuations
Disadvantages of OTM Spreads
- Lower premium: You collect less credit per trade
- Worse risk/reward: You risk more than you can make
- Slower theta decay: Time decay accelerates closer to expiration
- Big moves hurt more: When you lose, losses can be significant relative to premium
Example: OTM Put Credit Spread
Stock XYZ is trading at $100. You sell an OTM put credit spread:
- Sell the $90 put for $1.00
- Buy the $85 put for $0.40
- Net credit: $0.60 ($60 per contract)
- Max loss: $4.40 ($440 per contract)
- Probability of profit: ~75%
Comparing the Numbers
Here is a side-by-side comparison of a typical ATM vs OTM spread on the same underlying:
| Metric | ATM Spread | OTM Spread |
|---|---|---|
| Premium Collected | $2.00 | $0.60 |
| Max Loss | $3.00 | $4.40 |
| Win Rate | ~50% | ~75% |
| Return on Risk | 67% | 14% |
Which Should You Trade?
The best choice depends on your trading style, risk tolerance, and market outlook:
Trade ATM Spreads When:
- You have a strong directional conviction
- You want maximum premium and can manage the position actively
- Implied volatility is high and you want to capture more premium
- You are comfortable with lower win rates but higher wins
Trade OTM Spreads When:
- You want higher probability trades
- You prefer a more passive, set-and-forget approach
- You are building consistent income over time
- You want to sleep better at night with less position stress
The math truth: Over many trades, both approaches can be profitable. ATM spreads make more per win but win less often. OTM spreads win more often but make less per win. What matters is disciplined execution and proper position sizing.
A Balanced Approach
Many successful traders use a combination of both ATM and OTM spreads. For example:
- Use OTM spreads as your core income strategy for consistent returns
- Add ATM spreads when you have high conviction directional trades
- Scale your position size based on the probability profile
Track Your Spread Performance
Pro Trader Dashboard tracks all your spreads and shows you which strike selection strategies work best for your trading. See your win rates by moneyness and optimize your approach.
Summary
Choosing between ATM and OTM spreads is not about finding the "better" option. It is about matching your strategy to your goals and risk tolerance. ATM spreads offer higher premiums but lower win rates, while OTM spreads provide higher probabilities with smaller returns. Understanding these trade-offs helps you build a spread trading approach that fits your personality and objectives.
Learn more about spread strategies in our guides on credit spreads vs debit spreads and understanding options moneyness.