What Does It Mean for an Option to Be In the Money?

“In the money” is a fundamental concept in options trading that describes the intrinsic value an option contract holds. This term indicates whether exercising an option would result in an immediate financial benefit. Understanding this concept is important for comprehending how options are valued. An option’s status as “in the money” directly relates to the relationship between the underlying asset’s current market price and the option’s predetermined strike price.

Call Options In the Money

A call option provides the holder with the right, but not the obligation, to purchase an underlying asset at a specified price, known as the strike price, on or before a certain expiration date. For a call option to be considered “in the money,” the current market price of the underlying asset must be higher than the option’s strike price. This relationship indicates that the option has intrinsic value.

For example, consider a call option with a strike price of $50 on a stock currently trading at $55 per share. This call option would be “in the money” because the holder could buy the stock at $50, which is less than its current market value of $55. The intrinsic value of this “in the money” call option is calculated as the current market price of the underlying asset minus the strike price. In this instance, the intrinsic value would be $5 ($55 – $50). This intrinsic value represents the immediate profit available if the option were exercised at that moment.

Put Options In the Money

A put option grants the holder the right, but not the obligation, to sell an underlying asset at a specified strike price on or before a particular expiration date. A put option is considered “in the money” when the current market price of the underlying asset is lower than the option’s strike price.

For instance, imagine a put option with a strike price of $50 on a stock that is currently trading at $45 per share. This put option would be “in the money” because the holder could sell the stock at $50, which is higher than its current market value of $45. The intrinsic value of an “in the money” put option is determined by subtracting the current market price of the underlying asset from the strike price. In this example, the intrinsic value would be $5 ($50 – $45). This reflects the immediate financial benefit if the option were exercised.

Out of the Money and At the Money

An option is “out of the money” when it has no intrinsic value. For a call option, this occurs when the underlying asset’s current market price is below the strike price, making it unprofitable to exercise. For example, a call option with a $50 strike price on a stock trading at $45 would be “out of the money.”

Conversely, a put option is “out of the money” when the underlying asset’s current market price is higher than the strike price. A put option with a $50 strike price on a stock trading at $55 would fall into this category. In both “out of the money” scenarios, exercising the option would result in a financial loss, so these options expire worthless before expiration.

An option is considered “at the money” when the strike price is equal to or very close to the current market price of the underlying asset. For instance, if a stock is trading at $50, both a call option and a put option with a $50 strike price would be “at the money.” “At the money” options, like “out of the money” options, have no intrinsic value. Their value is composed entirely of extrinsic value, often referred to as time value, which reflects their potential to move “in the money” before expiration.

Significance of In the Money Options

An “in the money” option has intrinsic value, which is the direct, positive difference between the option’s strike price and the underlying asset’s current market price. For a call, this is when the asset’s price exceeds the strike price; for a put, it’s when the strike price exceeds the asset’s price.

An “in the money” option is more likely to be exercised, especially as it approaches expiration. Many brokerages automatically exercise “in the money” options at expiration if they are “in the money” by at least $0.01, though specific thresholds can vary. This automatic exercise mechanism helps ensure that option holders realize the intrinsic value of their contracts. Intrinsic value is distinct from time value, which is another component of an option’s total premium and diminishes as the option approaches expiration.