What is the in the money option?

Definition:

“In the Money” options (ATM) are options that have a strike price equal to the current market price of the underlying stock. “In the Money” options do not have intrinsic value, but because they have time value, they can be profitable before expiration.

Definition and Examples of “In the Money” Options

“In the Money” options are options that have strike prices equal to the current market price of the underlying stock. The position of the strike price of the option relative to the price of the underlying stock is called “financial status.” Options can be “in the money,” “at the money,” or “out of the money,” as you will learn in detail below.

Options are contracts that grant the buyer the right, but not the obligation, to buy or sell a share at a specified strike price on a specified date. The right to buy is called a call option, and the right to sell is called a put option.

Note: Options are listed on brokerage platforms in an options chain that displays the available quotes and offers with strike prices, expiration dates, and option prices (also known as option premiums) and other data.

Below is a table containing examples of information that can be included in an options chain for XYZ stock:

Expires on: January 20, 2022 | XYZ Stock Price: $350

Call Price Strike Price Put Price

$12 $340 $0.50

$7 $345 $1

$2 $350 $2

$1 $355 $7

Since the XYZ stock price is $350, the call option with a $350 strike price and the put option with a $350 strike price for January (in the third row) will be “in the money” options.

How Does “In the Money” Option Work?

The status of the option determines what its intrinsic value is. You can use this information to infer the time value, or extrinsic value, of the option. The option’s value is determined by its intrinsic value, time value, and implied volatility. Before we discuss that formula, let’s get to know the three types of financial statuses.

In addition to “In the Money” options, options can be “in the money” (ITM) or “out of the money” (OTM). Call options are considered in the money if the strike price is below the stock price (since the options can be exercised for a profit) and out of the money if the strike price is above the stock price. The opposite is true for put options.

In the table above, the strike prices below $350 for XYZ stock are in the money for call options and out of the money for put options.

Note: Both in-the-money and out-of-the-money options have intrinsic value, but they still hold value. This is because there is still a possibility that the option will reach in-the-money status before it expires. This value (and the difference between the intrinsic value of the in-the-money option and the current option price) is called time value. When you buy an in-the-money option, you are buying the time value.

How Do Traders Use “In the Money” Options in a Straddle Strategy?

“In the Money” options are often used in an options trading strategy called a straddle strategy. In the straddle strategy, the trader buys both call and put options that are in the money for the same stock, with the same strike price and expiration date. The trader bets on a significant movement either up or down.

Suppose a technology company has a stock trading at $20 per share and is approaching an earnings report release. The trader sets up a straddle strategy by buying in-the-money call and put options with a strike price of $20 each at a cost of $2 per option. For the trader to make a profit, the stock price must increase or decrease by $4 per share, which is the total cost of the two options.

This strategy may seem easy because you can profit whether the stock prices rise or fall. But in the real world, it’s a bit more complicated. When there is more volatility, the prices of the options are higher, making it harder to achieve a profit. Like all trading decisions, buying a straddle strategy requires good timing, which is highly subjective.

How

Traders Use “In-the-Money” Options in Covered Call Strategy?

“In-the-money” options are often used in a covered call strategy. Stock owners can sell call options to generate income. If the buyer exercises the option, they must sell their shares at the strike price. If the option expires worthless, they keep the premium.

If you sell an in-the-money option, you’re likely to earn a higher premium, but you may have to sell at a lower price if the option is exercised (which is more likely). If you sell an out-of-the-money option, it’s less likely to be exercised, but the premium will not be substantial. “In-the-money” options are a middle ground, offering an attractive premium along with a lower chance of exercise.

If the option is in the money at expiration, traders need to submit a form to their broker requesting to exercise the option. In-the-money options are exercised automatically if they are in the money enough, but out-of-the-money options are not exercised automatically. If the option is in the money at expiration, traders can simply buy the same quantity of shares on the open market and bypass the exercise process.

Takeaway

“In-the-money” options are options where the strike price is equal to the underlying stock price. These options do not have intrinsic value, but they have time value (extrinsic value) in that they can become profitable before expiration. Investors using recovery and covered call strategies often utilize “in-the-money” options.

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Sources:

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and maintain the accuracy, reliability, and quality of our content.

Security and Exchange Commission. “Investor Bulletin: An Introduction to Options.” Accessed November 3, 2021.

Merrill. “Option Pricing.” Accessed November 3, 2021.

Fidelity. “Long Call Strategy.” Accessed November 3, 2021.

Source: https://www.thebalancemoney.com/what-is-an-at-the-money-option-5208335