In The Money (Option) - Explained
What is an In The Money Option?
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Table of ContentsWhat is In The Money?How Does In the Money Work?In The Money Call OptionsIn The Money Put OptionsOther ConsiderationsIn The Money Option Example
What is In The Money?
In The Money (ITM) refers to the favorable option value which the option holder enjoys in an option contact. The option value is considered favorable because the option holder can buy security less than the market price in a call option and sell for a price above the market price in a put option. In ITM, the strike price of an option is better or more favorable than the current market value of the underlying option of asset.
Here are the key takeaways:
- In option contracts, an option can be in the money (ITM) or at the money (ATM).
- If the strike price is less than the market price in a call option, the option is ITM option.
- In the case of a put option, the selling price is higher than the market price.
- Premiums of ITM are more than other options.
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How Does In the Money Work?
Generally, there is a stipulated price or strike price at which an underlying security is traded in an option contract. In this type of contract, an option holder has the right and not the obligation to buy or sell the asset at the strike price at an agreed date. However, in the case of in the money, ITM, the option value or strike price at which the option is traded is favorable than the market price of the underlying security. The type of option also determines how ITM plays out, if it is a call option, the holder can purchase the security at a price lower than market value the underlying security. If it is a put option, the security can be sold at a higher price.
In The Money Call Options
A typical call option is selected by an investor with the aim that the price of the underlying asset would increase by the redemption date, this means that the strike should outweigh the market price. An 'in the money' call option means that underlying asset has an intrinsic value which is lower than the current market value. Usually, when an investor purchases an option, an upfront fee is charged, this is called the premium. The premium is determined by many factors. A call option that is in the money also attract premium, which is paid by the investor. This is the difference between the strike price and market price for the option that is in ITM. This means the trader is not necessarily making profit.
In The Money Put Options
A put option can also be in the money, when this happens, it means the option holder has the right to sell the underlying asset at a strike price higher than the current market value of the asset. Investors buy stocks of this nature with the believe that the price of the stock would decrease before its maturity date and they would recover the premium incurred for the purchase of the put option.
In general, the amount investors pay as premiums for options depends on the state the option is. Options do not remain in the money (ITM) forever, an option can be at the money (ATM) and out of the money (OTM). When the market price of an underlying asset is the same at its strike price, the option is said to be at the money. However, in the case of OTM, the value of the underlying security is less favorable which is why premiums on OTMs are less than those of ITMs. Hence, premiums on ITM, OTM and ATM vary. An option that is in the money has certain pros and cons, this means they have good sides as well as drawbacks. The pros and cons include the following; Pros
- A call option in the money and is at its expiry date gives its holder the opportunity to make profits since it is purchased at a price below the market value.
- In the case of a put option in the money, the holder can also make a profit since the asset is sold for a price above the strike price.
- More costs are associated with in the money options, higher premiums are paid.
- Due to the expenses incurred and premium paid, an option that is in the money does not suggest that the holder is making any significant profit.
In The Money Option Example
Below is an example of in the money call option; If as at purchase, the strike price of a call option is $50 and at the trades at $58, an investor can buy the stock at $50 and sell at $58. This type of option is in the money, premium is paid on this stock.