What Is In The Money (ITM)?
In the money (ITM) means that a call option's strike price is below the market price of the underlying asset, or that the strike price of a put option is above the market price of the underlying asset. An option that is in the money has intrinsic value, whereas an option that is out of the money (OTM) does not.
Being ITM does not mean the trader is necessarily making a profit on the trade, because an option costs money to buy. ITM just means the option is worth exercising.
How Call Options and Put Options Work
Options give the buyer the right, but not the obligation, of buying or selling the underlying security at a certain price, known as the strike price, before a certain date, known as the expiration date. Traders purchase call options, which give them the right to buy the underlying at the strike price, when they expect the market price of the underlying security to increase. They purchase put options, which enable them to sell the underlying at the strike price, when they expect the value of the underlying security to decrease.
A call option has intrinsic value when the strike price is lower than the market price of the underlying security, and a put option has intrinsic value when the strike price is higher than the market price of the underlying security.
When an option is ITM, the buyer of the option can exercise the call or put and receive the difference between the strike price and market price of the underlying. ITM doesn't mean the trader is making money. If buying an option that is already ITM, the trader will need it to move more ITM to make a profit. It needs to move by at least as much as the cost of the option, called the premium. If a trader buys an OTM option, they ideally want it to be ITM at expiry.
At the money (ATM) is another state an option can be in. It means the strike price and market price of the underlying are the same.
The amount of premium paid for an option depends in large part on whether the option is ITM, ATM, or OTM. Because they have intrinsic value, ITM options cost the most upfront. OTM options cost less.
Other factors that significantly affect the premium are volatility and time until expiration. Higher volatility and a longer time until expiration mean a greater chance that the option could move ITM. Therefore, the premium cost will be higher than if volatility was lower and/or time until expiration shorter.
- In the money means an option has intrinsic value.
- A call option has intrinsic value if the market price is above the strike price. This is because the call buyer has the right to buy at the strike price and sell at the market price, netting the difference.
- A put option has intrinsic value if the market price is below the strike price. This is because the put buyer has the right to sell at the strike price which is higher than the market price, netting the difference.
- An option can also be out of the money or at the money.
- ITM options are more expensive than options that are OTM or ATM. This is because ITM options have intrinsic value, while OTM and ATM options do not.
In The Money (ITM) Option Example
In the money means that a stock option has intrinsic value and is worth exercising. For example, if John buys a call option on Bank of America stock with a strike price of $30, and the price of the stock is sitting at $33, the option is considered to be in the money. This is because the option gives John the right to buy the stock for $30 but he could immediately sell the stock for $33, a difference of $3. Each options contract represents 100 shares, so the intrinsic value is $3 * 100 = $300.
If John paid $3.50 for the call, then he wouldn't actually profit from the trade. He paid $350 ($3.50 * 100 shares) to make the one contract trade, but he only benefits $300, so he is actually losing $50. Despite this, the option is still considered ITM because at expiry the option will have a value of $3. A call option with a strike price at $35 is out of the money (OTM) and therefore will be worthless at expiry; it has no intrinsic value because the strike price is above the current market price ($33).
While the strike price is fixed, the price of the underlying asset is not. The price of the underlying will constantly change, affecting how in the money the option is. An ITM option can move to ATM or even OTM. In the call option example above, if the stock falls from $33 to $29, the $30 strike price call is no longer ITM. It is $1 OTM.