In the Money Definition
“In the money” refers to an option that will produce a profit if it is exercised. It differs for call and put options. When a call option is in the money, the strike price for the underlying asset is less than the market price. Inversely, a put option is in the money if the strike priceStrike PriceExercise price or strike price refers to the price at which the underlying stock is purchased or sold by the persons trading in the options of calls & puts available in the derivative trading. Thus, the exercise price is a term used in the derivative market. of the underlying asset is more than the market price.
- An option may be ‘At the money,’ which means the strike price is equal to the market price. The holder of this option is at a break-even levelBreak-even LevelBreak-even analysis refers to the identifying of the point where the revenue of the company starts exceeding its total cost i.e., the point when the project or company under consideration will start generating the profits by the way of studying the relationship between the revenue of the company, its fixed cost, and the variable cost., meaning he/she would make no profit or loss if the option is exercised.
- An option may also be ‘Out of the money,’ which would mean that the holder of the option would incur a loss if the option is exercised.
In a nutshell, an option may be ‘In the money,’ ‘Out of the money,’ or ‘At the moneyAt The MoneyATM refers to a situation in which the option holder's exercise of the option results in no loss or gain since the exercise price or strike price is equal to the current spot price of the underlying security. ‘ depending on the relationship between the current market price of the underlying asset and the strike price of the option.
#1 – Call Option
Let us consider that you buy a call option on Apple Inc. at $ 200, which gives you the right but not the obligation to buy the underlying assetUnderlying AssetUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates.. The underlying asset, the stock of Apple Inc., is being traded in the market currently at $203. So, this option is said to be in the money as you can buy the stocks of Apple Inc. at $3 less than the market price.
This is the opposite for put optionsPut OptionsPut Option is a financial instrument that gives the buyer the right to sell the option anytime before the date of contract expiration at a pre-specified price called strike price. It protects the underlying asset from any downfall of the underlying asset anticipated..
#2 – Put Option
Now, you buy a put option on Apple Inc. at $200, which gives you the right but not the obligation to sell the underlying asset. A put option will be profitable or be in the money if the market value of the shares of Apple Inc. falls below $200. Because you can buy the shares from the market at a much cheaper rate than the rate at which you have agreed to sell it. If the underlying asset’s value falls in the market to $197, you can buy the shares from the market at $197 and exercise the put option at $200, which would give you a $3 profit.
Deep In the Money
An option that would lead to a large profit if exercised is referred to as being ‘Deep in the Money.’ This is a new term used by options traders for options that have a higher delta, 0.75 and above, to be precise. Delta is the change in the price of an asset (the option) to the corresponding change in the price of its underlying asset. The delta value for an option may be positive or negative depending on the option, whether call or put.
For example, if an option has a delta of 0.75, if the price of the underlying asset increases by $1 per share, everything else being equal, the value of the option will increase by $0.75 per share.
- In the Money, Option has a higher delta value than at the money option or an Out of the money option, which means that this option would give a higher return than an At the money option or an Out of the money option would give with the same move on the underlying asset or stock.
- The biggest advantage of having this type of option is that it has a lower risk than an At the money option or an Out of the money option. This is because the underlying asset would have intrinsic value at the time of expiration even if the value of the underlying stays unchanging, unlike an Out of the money option, which would result in a complete loss.
- The holder of this type of option will always benefit from exercising the option. Since the option has an intrinsic value, it is always worth exercising.
- In the money option consists of intrinsic value, the per contract value would be more than an At the money option or an Out of the money option. This makes an ITM contract a costly affair than an At the money option or an Out of the money option.
- The percentage gain on an ITM option is lesser than what would be gained on the same move for an At the money option or an Out of the money option. Although there is a profit in such an option, the percentage gain is much higher when an option is At the Money or Out of the moneyOut Of The Money”Out of the money” is the term used in options trading & can be described as an option contract that has no intrinsic value if exercised today. In simple terms, such options trade below the value of an underlying asset and therefore, only have time value..
- If the strike price is below the market price, a call option will have an intrinsic value.
- If the strike price is above the market price, a put option will have an intrinsic value.
- This option results in the profit of the holder of the option.
- The strike price is fixed, whereas the price of the underlying asset is based on the market.
- The price of the underlying asset will always keep on changing according to the market conditions.
- An in the money option can move to either an At the money option or an Out of the money option due to the change in the price of the underlying assets since it is always dependent on the market conditions.
- Deep In the money options, refer to the options which would result in a huge profit if exercised.
- Such options have an intrinsic value, and exercising it will give a profit to the holder of the option.
This has been a guide to what is In the Money Options and its definition. Here we discuss examples of in-the-money call and put options along with advantages and disadvantages. You can learn more about financing from the following articles –