A strike price above market value renders a put option in the money, while a strike price below market value renders a call option in the money.
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Options contracts grant their owners the right (but not the obligation) to buy or sell a particular asset (usually 100 shares of a stock) at a particular price (the option’s strike price) until or upon the contract’s expiration. Call options grant their owners the right to buy an asset, while put options grant their owners the right to sell an asset.
What Does ITM Mean? In the Money Defined
An options contract is considered “in of the money” if it has intrinsic value, meaning that if its owner exercised it, they would pay less than the current market value for a stock (in the case of a call option) or sell a stock for more than its current market value (in the case of a put option).
In other words, a call option is in the money if its strike price is lower than its spot price (market value), and a put option is in the money if its strike price is higher than its spot price.
In the Money (ITM) vs. Out of the Money (OTM) Options
The opposite of in the money is out of the money. Options contracts that do not have intrinsic value are considered out of the money.
If a call option’s strike price is higher than the current market price of the underlying stock, it is out of the money because if its owner exercised it, they would buy the stock for more than it’s worth. If a put option’s strike price is below the current market price of the underlying stock, it is out of the money because if its owner exercised it, they would sell the stock for less than it’s worth.
Since no investor would want to overpay for a stock (or be underpaid for a stock they are selling), options contracts that are out of the money are not usually exercised and are almost always allowed to expire worthless.
When Is a Call Option in the Money?
A call option is in the money if its strike price is lower than its spot price (the current market price of the underlying stock). This means that the owner of the option could exercise it in order to buy 100 shares of the underlying stock for less than market value.
When Is a Put Option In the Money?
A put option is in the money when its strike price is higher than its spot price. This means that the option’s owner could exercise it in order to sell 100 shares of the underlying stock for more than their market value.
In-the-Money Option Example: Acme Adhesives
Let’s say the stock of a fictional company called Acme Adhesives is currently trading at $22 per share. If an investor is bullish on the stock (thinks it will increase in price) because it has strong fundamentals and recently decreased its materials costs, they might bet on it going up in price by buying a call option contract for 100 shares with a strike price of $24 that expires in eight weeks.
Since the stock currently trades at $22, this call option is out of the money, so the premium the investor paid for it is relatively low because it lacks intrinsic value. After five weeks, Acme adhesive’s stock price rises to $26 due to higher-than-forecasted earnings and growth in sales.
The investor’s call option contract is now in the money because it could be exercised in order to purchase shares at lower than market value. The investor could now either exercise the contract and pay $2,200 (as opposed to the market value of ($2,600) for 100 shares or resell the contract for a profit.
How Does Being in the Money Affect an Option’s Premium?
The moneyness of an option is always included in its premium (price) because being in the money gives an option intrinsic (real) value. An option’s premium is based on three things—its moneyness, the amount of time remaining until its expiration, and the volatility of the underlying asset.
So, if an option is in the money by $3, its premium would be $3 plus its time value plus its volatility value. For example, an option contract that is in the money by $3 and has $1 worth of volatility and time value would cost an investor $400 ($4 * 100 shares).
Because the intrinsic value of an in-the-money options contract is included in its premium, an investor can only profit off of the contract if it moves further into the money, thereby increasing its intrinsic value. If the price of the underlying stock remains unchanged, the investor would experience loss on the trade due to the premium they paid for the contract.
What Happens When Options Expire in the Money?
If an option is in the money and approaching expiration, it is in its owner’s best interest to either sell or exercise the option regardless of whether they made money on it. Occasionally, however, an investor might be unavailable at the time or forget to do this.
If an investor does not resell or exercise an expiring option, the investor’s brokerage (or the Option Clearing Corporation) usually exercises the option automatically on the investor’s behalf. In the case of a call option, this means purchasing 100 shares of the underlying stock at the strike price. In the case of a put, this means selling 100 shares.
If the investor does not have enough money in their account (or enough shares in their possession) to exercise, the contract may be automatically exercised on margin (money borrowed from the brokerage), or the brokerage may attempt to contact the investor.
Investors should always monitor their options contracts, especially as they approach expiration. Each investor should check with their broker for their specific policies on ITM options that are approaching expiry.
