What Does “In the Money” Mean for Options?

Options are financial contracts that offer a way to engage with the price movements of various assets without directly owning them. They come with specific language. Understanding this terminology is fundamental for comprehending their mechanics and navigating the market effectively.

Understanding Core Options Terminology

An option contract is tied to an “underlying asset,” which is the security or commodity the option holder has the right to buy or sell. This can include stocks, exchange-traded funds (ETFs), or other financial instruments. Each option contract also has a “strike price,” the predetermined price at which the underlying asset can be bought or sold if the option is exercised.

The “expiration date” is the specific day when the option contract ceases to exist. There are two primary types of options: a “call option” gives the holder the right, but not the obligation, to buy the underlying asset at the strike price by the expiration date. Conversely, a “put option” grants the holder the right, but not the obligation, to sell the underlying asset at the strike price by the expiration date.

Defining “In the Money” for Call Options

A call option is considered “in the money” (ITM) when the current market price of its underlying asset is higher than the option’s strike price. This condition means that the holder could immediately purchase the asset at a price lower than its current market value. Therefore, exercising such an option would result in an immediate theoretical profit, before accounting for the cost of the option itself.

For example, if an investor holds a call option for a stock with a strike price of $50, and the stock is currently trading at $55 per share, that call option is “in the money” by $5. The investor has the right to buy shares at $50, even though they are trading at $55 in the open market. This difference represents the intrinsic value of the option.

Defining “In the Money” for Put Options

A put option is “in the money” when the current market price of the underlying asset is lower than the option’s strike price. This situation provides the holder with the ability to sell the asset at a price higher than its current market value. Exercising this option would lead to an immediate theoretical gain.

Consider a scenario where an investor owns a put option for a stock with a strike price of $100, and the stock’s current market price is $90. In this case, the put option is “in the money” by $10. The investor possesses the right to sell the shares at $100, even though the market price is only $90. This $10 difference per share signifies the option’s intrinsic value.

Related Options Concepts

Beyond “in the money,” options can also be classified as “out of the money” (OTM) or “at the money” (ATM). An option is “out of the money” if exercising it would not result in an immediate profit. For a call option, this occurs when the underlying asset’s price is below the strike price. Conversely, a put option is “out of the money” when the underlying asset’s price is above its strike price.

“Out of the money” options have no intrinsic value. The third state, “at the money,” describes an option where the underlying asset’s price is approximately equal to the option’s strike price. In this situation, it also lacks intrinsic value.

The Importance of “In the Money”

The “in the money” status of an option is important due to its intrinsic value. Intrinsic value is the immediate profit an option would yield if it were exercised at the current underlying price. This value is calculated as the difference between the underlying asset’s price and the option’s strike price, always being a positive amount or zero. An “in the money” option possesses this intrinsic value, distinguishing it from “out of the money” options that have no such immediate worth.

“In the money” options are more likely to be exercised or will retain a portion of their value closer to their expiration date. This is because their inherent value provides a clear benefit to the holder. While other factors also influence an option’s total price, the presence of intrinsic value is important for understanding an option’s immediate profitability and its overall worth.