Key Takeaways
- ITM options have intrinsic value and are profitable to exercise.
- Call ITM when spot price exceeds strike price.
- Put ITM when spot price is below strike price.
- ITM options carry higher premiums due to built-in profit.
What is In the Money (ITM)?
In the Money (ITM) describes an options contract that holds intrinsic value because its strike price is favorable compared to the current market price of the underlying asset, making it profitable to exercise immediately. For a call option, ITM means the asset's market price exceeds the strike price, while for a put option, it means the market price is below the strike price.
This concept is central to options trading, where understanding ITM status helps you evaluate potential profits and risks related to contracts like a call option.
Key Characteristics
ITM options have distinct traits that affect their value and trading behavior:
- Intrinsic Value: ITM options possess intrinsic value, which is the difference between the underlying asset’s market price and the strike price.
- Higher Premiums: Because of built-in profit potential, ITM options generally trade at higher premiums than out-of-the-money options.
- Exercisability: ITM status often encourages early exercise, especially if the option holder wants to capture intrinsic value before expiration (early exercise).
- Reduced Time Value: Compared to out-of-the-money options, ITM options have less time value but greater sensitivity to price changes, influenced by factors like gamma.
- Profit Potential: Call buyers profit when the asset price rises above strike, while put buyers benefit when the asset price falls below strike.
How It Works
When you hold an ITM option, your contract has immediate intrinsic value, meaning exercising it would yield a profit before considering the premium paid. For example, a call option with a strike price of $50 becomes ITM if the underlying asset’s market price rises to $55, giving you a $5 per share advantage.
However, profitability depends on the premium paid and other factors like time decay and volatility. Understanding fair pricing and value adjustments is crucial, which ties into concepts like fair value and option Greeks.
Examples and Use Cases
In practical investing, ITM options are used for both speculative and hedging purposes:
- Airlines: Investors may buy ITM calls on Delta to capitalize on bullish expectations of the airline sector’s recovery.
- Hedging: Owning shares of a company, you might purchase ITM puts to protect against downside risk, similar to strategies used by investors in Apple.
- Growth Stocks: Traders might prefer ITM options on stocks from the best growth stocks list to leverage anticipated price rises while limiting risk.
Important Considerations
While ITM options provide intrinsic value, you should consider the premium cost and the time left until expiration before exercising. Sometimes, holding or selling the option is more profitable than immediate exercise due to remaining time value.
Choosing the right broker and platform can affect your ability to trade ITM options efficiently. For beginners, exploring the best online brokers ensures access to tools and pricing suited for options trading strategies involving ITM contracts.
Final Words
In-the-money options offer intrinsic value, making them potentially profitable to exercise or sell. To leverage this advantage, analyze your current positions to identify ITM contracts and evaluate whether exercising or closing them aligns with your financial goals.
Frequently Asked Questions
In the Money (ITM) refers to an options contract that has intrinsic value because its strike price is favorable compared to the current market price of the underlying asset, making it profitable to exercise immediately.
A call option is In the Money when the underlying asset's market price is higher than the option's strike price, meaning you could buy the asset below its current market value.
A put option is In the Money when the market price of the underlying asset is below the strike price, allowing the option holder to sell the asset at a higher than market price.
ITM options carry intrinsic value due to favorable strike prices, which increases their premiums. However, they usually have lower time value compared to out-of-the-money options.
If a stock is trading at $35 and you hold a call option with a strike price of $25, the option is ITM because the intrinsic value is $10 per share, making it profitable to exercise.
For sellers, an ITM position means potential losses since the market price moves against their position—for call sellers, if the spot price exceeds the strike price, and for put sellers, if the spot price falls below the strike price.
If your option is ITM, exercising it immediately can be profitable because the strike price is favorable compared to the market price, though some traders may choose to sell the option instead.
