What Is "In the Money" (ITM)?
"In the money" (ITM) is an expression that refers to an option that possesses intrinsic value. ITM thus indicates that an option has value in a strike price that is favorable in comparison to the prevailing market price of the underlying asset:
- An in-the-money call option means the option holder has the opportunity to buy the security below its current market price.
- An in-the-money put option means the option holder can sell the security above its current market price.
An option that is ITM does not necessarily mean the trader is making a profit on the trade. The expense of buying the option and any commission fees must also be considered. In-the-money options may be contrasted with out of the money (OTM) options.
- A call option is in the money (ITM) if the market price is above the strike price.
- A put option is in the money if the market price is below the strike price.
- An option can also be out of the money (OTM) or at the money (ATM).
- In-the-money options contracts have higher premiums than other options that are not ITM.
A Brief Overview of Options
Investors who purchase call options are bullish that the asset's price will increase and close above the strike price by the option's expiration date. Options are available to trade for many financial products such as bonds and commodities but, equities are one of the most popular for investors.
Options give the buyer the opportunity—but not the obligation—of buying or selling the underlying security at the contract-stated strike price, by the specified expiration date. The strike price is the transaction value or execution price for the shares of the underlying security.
Options come with an upfront fee cost, called the premium, that investors pay to buy the contract. Multiple factors determine the premium's value. These factors include the current market price of the underlying security, time until the expiration date, and the value of the strike price in relationship to the security's market price.
Typically, the premium shows the value market participants place on any given option. An option that has value will likely have a higher premium associated with it versus one that has little chance of making money for an investor.
The two components of options premium are intrinsic and extrinsic value. In-the-money options have both intrinsic and extrinsic value, while out of the money options' premium contain only extrinsic (time) value.
Options trading can be extremely volatile, especially in times of significant market changes such as with large-scale macroeconomic events like natural disasters, economic plunges, and other such events.
In-the-Money Call Options
Call options allow for the buying of the underlying asset at a given price before a stated date. The premium comes into play when determining whether an option is in the money or not, but can be interpreted differently, depending on the type of option involved. A call option is in the money if the stock's current market price is higher than the option's strike price. The amount that an option is in the money is called the intrinsic value meaning the option is at least worth that amount.
For example, a call option with a strike of $25 would be in the money if the underlying stock was trading at $30 per share. The difference between the strike and the current market price is typically the amount of the premium for the option. Investors looking to buy a particular in-the-money call option will pay the premium or the spread between the strike and the market price.
However, an investor holding a call option that's expiring in the money can exercise it and earn the difference between the strike price and market price. Whether the trade was profitable or not depends on the investor's total expense of buying the contract and any commission to process that transaction.
ITM doesn't mean the trader is making money. When buying an ITM option, the trader will need the option's value to move farther into the money to make a profit. In other words, investors buying call options need the stock price to climb high enough so that it at least covers the cost of the option's premium.
In-the-Money Put Options
While call options allow the purchase of an asset, a put option accomplishes the opposite action. Investors buy these options contracts that give them the ability to sell the underlying security at the strike price when they expect the value of the security to decrease. Put option buyers are bearish on the movement of the underlying security.
An in-the-money put option means that the strike price is above the market price of the prevailing market value. 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.
As the expiration date nears, the value of the put option will fall in a process known as time decay.
Pros and Cons
A call option holder that is in the money (ITM) at expiry has a chance to make a profit if the market price is above the strike price.
An investor holding an in-the-money put option has a chance to earn a profit if the market price is below the strike price.
In-the-money options are more expensive than other options since investors pay for the profit already associated with the contract.
Investors must also consider premium and commission expenses to determine profitability from an in the money option.
When the strike price and market price of the underlying security are equal, the option is called at the money (ATM). Options can also be out of the money, meaning the strike price is not favorable to the market price. An OTM call option would have a higher strike price than the market price of the stock.
Conversely, an OTM put option would have a lower strike price than the market price. An OTM option means that the option has yet to make money because the stock's price hasn't moved enough to make the option profitable. As a result, OTM options usually have lower premiums than ITM options.
In short, the amount of premium paid for an option depends in large part on the extent an option is ITM, ATM, or OTM. However, many other factors can affect the premium of an option including how much the stock fluctuates, called volatility, and the time until the expiration. Higher volatility and a longer time until expiration mean a greater chance that the option could move ITM. As a result, the premium cost is higher.
Real-World Example of ITM Options
Let's say an investor holds a call option on Bank of America (BAC) stock with a strike price of $30. The shares currently trade at $33 making the contract in the money. The call option allows the investor to buy the stock for $30, and they could immediately sell the stock for $33, giving them a $3 per share difference. Each options contract represents 100 shares, so the intrinsic value is $3 x 100 = $300.
If the investor paid a premium of $3.50 for the call, they would not profit from the trade. He would have paid $350 ($3.50 x 100 = $350) while only gaining $300 on the difference between the strike price and market price. In other words, he'd lose $50 on the trade. However, the option is still considered ITM because, at expiry, the option will have a value of $3 even though John's not earning a profit.
Also, if the stock price fell from $33 to $29, the $30 strike price call is no longer ITM. It would be $1 OTM. It's important to note that while the strike price is fixed, the price of the underlying asset will fluctuate affecting the extent to which the option is in the money. An ITM option can move to ATM or even OTM before its expiration date.