An option contract is a financial derivative that represents a holder who buys a contract sold by a writer. The "moneyness" of an option describes a situation that relates the strike price of a derivative to the price of the derivative's underlying security. A put option can either be out of the money, at the money or in the money.
An in the money put option is one where its strike price is greater than the market price of the underlying asset.
That means the put holder has the right to sell the underlying at a price that is greater than where it currently trades.
This allows for an immediate profit if they buy the shares back at the market price, therefore the price of an in the money put closely tracks changes in the underlying.
Options Contract Definition
How Do Put Options Work?
A put option buyer grants the right—but not the obligation—to sell a specified quantity of the underlying security at a predetermined strike price on or before its expiration date. On the other hand, the seller or writer of a put option is obligated to buy the underlying security at a predetermined strike price if the corresponding put option is exercised.
Put options are used as downside protection since if you own the underlying asset and you have the right to sell it at some price, it effectively gives you a guaranteed floor price. Put options can also be used to speculate on an underlying if you think that it will go down in price. Thus, a put can give short market exposure with limited risk if the underlying in fact rises.
A put option should only be exercised if the underlying security is in the money.
When Is a Put Option "In the Money?"
A put option is considered in the money (ITM) when the current market price of the underlying security is below the strike price of the put option. The put option is in the money because the put option holder has the right to sell the underlying security above its current market price. When there is a right to sell the underlying security above its current market price, the right to sell has value equal to at least the amount of the sale price less the current market price.
An in the money put option therefore is one where the strike price is above the current market price. An investor holding an ITM put option at expiry means the stock price is below the strike price and it's possible the option is worth exercising. A put option buyer is hoping the stock's price will fall far enough below the option's strike to at least cover the cost of the premium for buying the put.