In the Money, the intrinsic value of an option
In short:
“In the money” (ITM) is a term used to refer to an option where the underlying asset’s price justifies the execution of the options contract. In other words, ITM options contracts have a dollar gain to be realized between their strike price and the asset’s current market price.
- For a call option to be in-the-money, the underlying assets price must be higher than the options strike price.
- For a put option to be in-the-money, the underlying assets price must be lower than the options strike price.
When an option is in the money, it is said to have intrinsic value. It should be noted, however, that just because an options contract is in the money does not mean that the options contract will be profitable for the option holder. To be profitable, the option must be in the money far enough to produce a gain large enough to pay for the options premium and any brokerage commissions.
Key Points
- In the money is a term that refers to options contracts where a gain can be realized if executed (not necessarily a profit).
- A call option is in the money if the underlying assets price is higher than the call options strike price.
- A put option is in the money if the underlying assets price is lower than the put options strike price.
- Options that are in the money are said to have intrinsic value.
In-depth:
In-the-Money Call Options
A call option gives the option owner the right but not the obligation to buy the underlying asset at a set price within a certain amount of time. One of the primary components of determining if a call option is profitable or not is if it is in the money.
A call option is in the money if the current price of the underlying asset is higher than the option’s strike price. To be profitable, the underlying assets price must exceed the strike price by enough to compensate for the cost of the option (option premium & commission).
For example, say we are looking at a call option with a strike price of $100. If the current price of the underlying asset is $110 the call option is in the money.
If we were to buy this call option that is already in the money, we would expect the premium to be more than $10. This is because $10 represents the intrinsic or immediate value of the option. In addition to this intrinsic value, we would also pay for extrinsic value, or the value of additional time for the underlying asset to increase even further before the options expiration.
It is important to remember that just because an option is in the money does not mean the options contract will be exercised at a profit.
Key idea, call options are in the money when the underlying assets price is higher than the strike price.
In-the-Money Put Options
Unlike call options which give the option owner the right to buy, put options give the option owner the right to sell. The reason an investor would want to buy a put option is if they think the value of the underlying asset is going to decrease. By buying a put option, an investor can either protect or profit from the decline in the asset’s value by owning the right to sell the asset at a higher price.
For a put option to be in the money, the value of the underlying asset must be lower than the strike price of the put option.
For example, say we are looking at a put option with a strike price of $30. If the current price of the underlying asset is only $15 the put option is in the money.
Like with call options, for a put option to be profitable it must be deep enough in the money that when exercised it will cover the cost of the put option (premium & commission).
Key idea, put options are in the money when the underlying assets price is lower than the strike price.
In-the-Money vs Out-of-the-Money
The key difference between in-the-money options (ITM) and out-of-the-money (OTM) options is the type of value they hold. In the money options hold both intrinsic and extrinsic value, that is, ITM options have an immediate value which is the difference gain between the assets price and the strike as well as time value.
OTM options on the other hand have only extrinsic value. The value OTM options hold is entirely made up of the time until the option expires and the implied volatility of the underlying asset. In other words, the likelihood of the option expiring in the money.
Ultimately, the value of both ITM and OTM options is reflected by the option premium which is the cost to own the option.