What Is "in the Money" (ITM)?
The phrase in the money (ITM) refers to an option that possesses intrinsic value. An option that's in the money is an option that presents a profit opportunity due to the relationship between the strike price and the prevailing market price of the underlying asset.
- An in-the-money call option means the option holder can 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.
Due to the expenses (such as commissions) involved with options, an option that is ITM does not necessarily mean a trader will make a profit by exercising it.
Options can also be at the money (ATM) and out of the money (OTM).
- 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.
- Investors should account for the costs of buying options when figuring potential profit from an in the money option.
Options contracts exist on many financial products, including bonds and commodities. However, options on equities are one of the most popular types of options for investors.
Options give buyers the opportunity—but not the obligation—to buy or sell the security underlying the option contract at the contract-stated strike price by the specified expiration date. The strike price is what the investor would pay for the shares. It's the execution price (or transaction value).
Investors pay a fee called the premium to buy an option 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.
The premium indicates the value that market participants place on any given option. An option that has value will likely have a higher premium than one that has little chance of making money for an investor.
The two components of options premiums are intrinsic and extrinsic value. In-the-money options have both intrinsic and extrinsic value, while out of the money options premiums contain only extrinsic (time) value.
The options market can be extremely volatile, especially in times that move the market, such as large-scale macroeconomic events like natural disasters and economic plunges.
In-the-Money Call Options
Call options allow for the purchase of the underlying asset at a given price before a stated date. The amount of premium depends on whether an option is in the money or not, but can be interpreted differently, depending on the type of option involved.
Investors who purchase call options believe that the underlying asset's price will increase and close above the strike price by the option's expiration date. They are bullish on the price direction of the stock.
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. It means that the option is worth at least that amount.
A call option with a strike of $25 would be in the money if the underlying stock were trading at $30 per share. The difference between the strike price and the current market price is typically the amount of the premium for the option. So, 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.
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 is profitable or not depends on the investor's total transaction expense.
Therefore, ITM doesn't necessarily mean the trader will make money. To make a profit, the trader needs the option's in-the-money value to increase so that it does more than cover the cost of the option's premium.
Time decay refers to the loss of value that options experience as the contract expiration date approaches. The closer an option contract gets to the expiration date, the greater the decrease in value will be. However, in-the-money options see less time decay (due to their intrinsic value) than options that are out of the money or at the money.
In-the-Money Put Options
A put option contract gives investors the right to sell the underlying security at the contract strike price before the expiration date.
Investors who purchase put options believe that the underlying asset's price will decrease and close below the strike price by the option's expiration date. They are bearish on the price direction of the underlying security.
An in-the-money put option means that the strike price is above the market price of the underlying security. A put option that's in the money at expiry may be worth exercising. A put option buyer is hoping the stock's price will fall far enough below the option's strike to more than cover the premium paid to buy the put.
Pros and Cons
An investor with a call option that is in the money (ITM) at expiry has a chance to make a profit since the market price is above the strike price.
An investor holding an in-the-money put option has a chance to earn a profit since 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 of an in-the-money option.
ATM and OTM options
When the strike price and market price of the underlying security are equal, the option is considered at the money (ATM). Options can also be out of the money (OTM), meaning they have no intrinsic value.
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.
Since an OTM option has less value than an ITM option, it usually will have a lower premium.
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, other factors can affect the premium of an option including how much the stock fluctuates (its 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 is higher.
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. Therefore, the option contract is in the money. The investor can buy the stock for $30 and immediately sell it for $33 for a gain of $3 per share. Since each option contract represents 100 shares, the intrinsic value is $3 x 100 = $300.
Now say the investor's cost was a premium of $3.50. They would have paid $350 ($3.50 x 100 = $350) but gained only $300. In other words, they'd lose $50 on the trade. So, in this case, even though the option is ITM, it would not make for a profitable trade.
If the stock price fell from $33 to $29, the call option with the $30 strike price 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 and affect the extent to which the option is in the money. An ITM option can move to ATM and OTM before its expiration date.
What Is a Strike Price?
A strike price is the price designated by an options contract as the price at which an investor has the right to buy (with a call option) or sell (with a put option) the contract's underlying security.
What Does Deep in the Money Mean?
Deep in the money refers to options that are in the money by at least $10. For a call option, that means the strike price would be more than $10 under the prevailing market price. For a put option, the strike price would be more than $10 above the market price. Due to how deeply they are in the money, the prices of these options usually move just as the price of the underlying asset moves.
How Much Is an At-the-Money Option Worth?
At-the-money options are options where the strike price is the same as the market price of the underlying security. In such an instance, no money can be made by exercising the option. Thus, the option has no intrinsic value.