What Does ‘In the Money’ (ITM) Mean?
‘In the Money’ (ITM) is a term used in options trading to describe an option that has intrinsic value. Intrinsic value arises when there is a favorable discrepancy between the option’s strike price and the prevailing market price of the underlying asset.
- An in-the-money call option allows the holder to buy the underlying asset below the current market price.
- An in-the-money put option enables the holder to sell the underlying asset above the current market price.
Key Takeaways
- A call option is ITM when the market price exceeds the strike price.
- A put option is ITM when the market price is below the strike price.
- These options often carry higher premiums due to their intrinsic value.
- Evaluating the total cost, including premiums, is essential for profitability.
Understanding Options
Options contracts cover various financial products like equities, bonds, and commodities. Among these, options on equities are particularly popular. These contracts provide the buyer with the right—but not the obligation—to buy or sell the underlying asset at the stipulated strike price up until the expiration date.
Premium Costs
Investors pay a fee known as the premium to purchase an options contract. Factors influencing the premium include the current market price, time until expiration, and the relationship between the strike price and the market price.
- Higher intrinsic value often leads to higher premiums on ITM options.
Intrinsic vs. Extrinsic Value
Options premiums consist of intrinsic and extrinsic value. An ITM option includes both, while an OTM option’s premium is composed solely of extrinsic value. Market volatility and macroeconomic events can significantly affect these values.
In-the-Money Call Options
Call options enable the purchase of the underlying asset at a predetermined price. These options become profitable if the asset’s market price exceeds the strike price before expiration.
For example, if an option has a strike price of $25 and the underlying stock trades at $30, the call option is $5 in the money.
In-the-Money Put Options
Put options allow the sale of the underlying asset at a specific price. These options are considered ITM if the market price falls below the strike price before expiration. For instance, if the strike price is $40 and the stock is trading at $35, the put option is $5 in the money.
Pros and Cons
Pros:
- Potential for profit with ITM options due to favorable market-to-strike price relationship.
Cons:
- Higher premiums than OTM or ATM options, necessitating significant price movements to achieve profitability.
- Additional costs like commissions can affect the overall profit.
ATM and OTM Options
When a strike price equals the underlying asset’s market price, the option is ‘At the Money’ (ATM). In contrast, ‘Out of the Money’ (OTM) options have no intrinsic value and generally carry lower premiums.
Premium Values
The premium paid for an option significantly depends on its ITM, ATM, or OTM status. Factors like market volatility and time until expiration also play crucial roles.
Example of ITM Options
Imagine you hold a call option on a stock trading at $33, with a strike price of $30. Here, the option is $3 ITM. If the premium cost was $3.50 per share, you’d pay $350 (for 100 shares) but gain only $300, leading to a net loss of $50. Fluctuations in the underlying asset price can turn ITM options to ATM or even OTM before the expiration date.
Final Thoughts
Ensuring a comprehensive understanding of ITM options is crucial for making informed investment decisions. Always consider premiums, intrinsic and extrinsic values, and transaction costs when evaluating the potential for profit.
Related Terms: Options Trading, Strike Price, Premium, Intrinsic Value, Extrinsic Value, Time Decay.
