What does In The Money (ITM) mean?
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, where as 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.
Breaking Down In The Money (ITM)
In the money means that a stock option has intrinsic value and is worth exercising. For example, if John buys a call option on ABC stock with a strike price of $12, and the price of the stock is sitting at $15, the option is considered to be in the money. This is because the option gives John the right to buy the stock for $12 but he could immediately sell the stock for $15, a gain of $3. Each options contract represents 100 shares, so the profit is $3 x 100 = $300.
If John paid $3.50 for the call, then he wouldn't actually profit from the trade. He paid $350 ($3.50 x 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. An option with a strike price at $16 is out of the money (OTM) and therefore will be worthless at expiry; it has not intrinsic value.
How Call Options and Put Options Work
Options confer 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, when they expect the market price of the underlying security to increase. They purchase put options, which enable them to sell, when they expect the value of the underlying security to decrease.
Options have intrinsic value when the strike price is lower, in the case of a call option, or higher, in the case of the put option, than the security's market price. The buyer can exercise the call or put and profit on the difference. As mentioned, ITM, doesn't mean the trade 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 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 lower and/or time until expiration shorter.