In the money

In the money” (ITM) is a term used in options trading to describe an option that has intrinsic value, meaning it would be profitable to exercise. This status depends on the relationship between the option’s strike price and the current price of the underlying asset.

Call Options:

A call option is considered in the money when the market price of the underlying asset is above the strike price. For instance, if you hold a call option with a strike price of $50 and the current market price of the stock is $55, the option is in the money by $5. This $5 represents the intrinsic value of the option, which is the real, tangible profit that could be realized if the option were exercised immediately.

Put Options:

Conversely, a put option is in the money when the market price of the underlying asset is below the strike price. Using the previous example in reverse, if you have a put option with a strike price of $50 and the current market price is $45, the option is in the money by $5. This means that exercising the option would result in a profit equal to the difference between the strike price and the current market price, minus any premium paid for the option.

Key Points:

1. Value Creation: Being in the money adds value to the option because it means that exercising the option would lead to a gain, excluding the cost of the premium. The deeper an option is in the money, the greater its intrinsic value.
2. Impact on Premiums: In the money options are more expensive to buy than at the money or out of the money options because they already contain intrinsic value. The premium for these options includes this intrinsic value plus any remaining time value.
3. Strategic Considerations: Options traders might purchase in the money options to increase the likelihood of profitability, albeit at a higher cost. These options are often used for more conservative strategies where the trader expects the underlying asset to continue moving favorably but desires a cushion against minor price reversals.
4. Exercise Decisions: For options that are in the money, the decision to exercise or not can depend on various factors, including remaining time value, expected future volatility, and transaction costs. Sometimes, even though an option is in the money, it might be more beneficial to sell the option rather than exercise it to capture its time value.

Conclusion:

Understanding whether an option is in the money is crucial for evaluating its potential profitability and making informed trading decisions. This status can influence a trader’s strategy, especially when assessing risk versus reward in scenarios where the market’s direction is uncertain. Being adept at recognizing and utilizing in the money options is a valuable skill in the arsenal of any options trader.