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In-the-Money (ITM) in Options Trading

Views 781Jul 9, 2024

In options trading, understanding terms like "in-the-money" (ITM), "at-the-money" (ATM), and "out-of-the-money" (OTM) is crucial. These terms describe the relationship between the strike price of an option and the current market price of the underlying asset. In this article, we'll delve into the concept of ITM, its implications on premiums, examples, trading strategies, and more.

What does "In-the-Money" (ITM) mean

ITM refers to a situation where the current market price of the underlying asset is favorable for the option holder. For call options, this means the underlying asset price is above the strike price, while for put options, it means the underlying asset price is below the strike price.

In contrast, OTM options have the opposite relationship. With call options, they're in OTM if the underlying asset price is trading below the call's strike price; a put option is OTM if the underlying's price is higher than the put's strike price.

For "at-the-money" options, they have a strike price equal to the current asset price, implying no intrinsic value. Understanding these terms helps traders assess the moneyness of options, crucial for making informed decisions.

How in-the-money affects premium

The intrinsic value of an option directly impacts its premium. ITM options inherently possess intrinsic value because they allow the holder to exercise the option with the potential for profit. This intrinsic value is the difference between the current market price and the strike price for the option.

As a result, ITM options generally have higher premiums compared to ATM or OTM options. Traders should consider this premium differential when evaluating potential trades.

calls and puts

In-the-money call options

ITM call options occur when the underlying asset's current price exceeds the option's strike price. For example, if a stock is trading at $60 and you hold a call option with a strike price of $50, the option is $10 ITM. In this scenario, the option holder can buy the stock at a lower price than its current market value, making the option valuable.

In-the-money put options

Conversely, ITM put options arise when the underlying asset's current price is higher than the option's strike price. For instance, if a stock is trading at $40 and you hold a put option with a strike price of $50, the option is $10 ITM. Here, the option holder can exercise the option to sell the stock at a higher price than its current market value.

commission-free options trading on moomoo

In-the-money examples

Let's illustrate an ITM call from both the buyer and seller's side.

As the buyer:

You purchase a call option for Company A with a strike price of $50. At the time of purchase, the stock is trading at $60 per share. As the stock price climbs to $70 before the option expiration date, your call option is now $20 ITM ($70 - $50).

If you exercise the option, you can buy shares at $50 and immediately sell them at $70, securing a $20 profit per share less how much was intially paid to purchase the $50 ITM call.

As the seller:

You have written (sold) an in-the-money (ITM) call option with a strike price of $100 on a stock that you own. The stock's current market price is $120 and it's ITM because the market price is above the strike price. You received a premium for selling this call option.  

In addition, as the writer, you have a potential obligation to sell the stock at $100 if the option buyer decides to exercise it, even though the stock's market value is $120. You may miss out on the additional $20 per share increase above the strike price but maybe you wanted to generate income through the premium.

And a few additional things to keep in mind. Selling call options can cap potential gains, which would be a drawback and selling ITM options leads to a greater chance of being assigned.

Potential Pros and Cons

Here's a comparison of the potential pros and cons of ITMs from both the buy and sell side for a call and a put.

Potential Pros

Buy side

Potential Cons

Buy side

ITM options can offer intrinsic value and time value, providing sort of a "buffer" for the option holder.

More expensive to enter than OTM options due to their intrinsic value

Increased probability of profitability due to higher deltas

There's a better chance for the option to be ITM at expiration

If the underlying stock moves against the trader, the loss on an ITM trade can be more significant due to the higher premium paid to enter the position.

With their intrinsic value, less affected by time decay as compared to an OTM option

Lower leverage as compared to OTM options

Potential Pros

Sell side

Potential Cons

Sell side

Collecting premiums from selling ITM options upfront.

Potential for assignment, obligating the seller to fulfill the contract.

Profit potential if the option expires OTM.

Limited profit potential to the premium collected.

Opportunity to utilize ITM options as part of hedging strategies.

Possible loss if the option expires ITM, requiring the seller to fulfill the contract at a less favorable price. Potentially unlimited loss on the sale of a call option.

How to Trade Options Using Moomoo

For a step-by-step guide to trading option on Moomoo, see here:

Step 1: Navigate to your Watchlist, then select a stock's "Detailed Quotes" page.

moomoo app watchlist

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

Step 2: Navigate to Options> Chain located at the top of the page.

Step 3: By default, all options with a specific expiration date are shown. For selective viewing of calls or puts, simply tap "Call/Put."

moomoo app options tab

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

Step 4: Adjust the expiration date by choosing your preferred date from the menu.

select expiration date

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

Step 5: Easily distinguish between options: white denotes out-of-the-money, and blue indicates in-the-money. Swipe horizontally to access additional option details.

confirm the moneyness

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

Step 6: Explore various trading strategies at the screen's bottom, offering flexibility for your investment approach.

switch between different options trading strategies

Disclaimer: Images provided are not current and any securities are shown for illustrative purposes only and is not a recommendation.

FAQs about in-the-money (ITM) options trading

What's the difference between in-the-money and out-of-the-money options?

In options trading, the terms "in-the-money" (ITM), "at-the-money" (ATM), and "out-of-the-money" (OTM) refer to the relationship between the strike price of an option and the current market price of the underlying asset.

  • ITM: The current market price of the underlying asset is favorable for the option holder. For call options, this means the asset price is above the strike price, while for put options, it means the asset price is below the strike price. ITM options have intrinsic value.

  • ATM: ATM options have a strike price equal to the current market price of the underlying asset. These options typically have no intrinsic value and are purely comprised of time value.

  • OTM: OTM options occur when the current market price of the underlying asset is below or above the strike price for the option holder. For call options, this means the underlying asset price is below the strike price, while for put options, it means the underlying asset price is above the strike price. OTM options have no intrinsic value and are comprised entirely of time (extrinsic) value.

When is a call or a put option ITM?

A call option is considered ITM when the market price of the underlying asset exceeds the option's strike price. This means the option holder has the potential to profit by exercising the option and purchasing the asset at a lower price than its current market value.

Conversely, a put option is considered ITM when the market price of the underlying asset is below the option's strike price. In this case, the option holder can potentially profit by exercising the option and selling the asset at a higher price than its current market value.

What happens when options expire ITM?

When options expire ITM, holders typically exercise their rights to buy or sell the underlying asset at the predetermined strike price. However, if not exercised, the options may automatically be assigned by the broker, resulting in either buying or selling the underlying asset at the agreed-upon price. Traders should be aware of expiration dates and exercise or close positions accordingly.

Understanding ITM options is essential for navigating the complexities of options trading effectively. By comprehending their implications on premiums, trading strategies, and risk management, investors can make more informed decisions to potentially enhance their trading endeavors.

Disclaimer: This content is for informational and educational purposes only and does not constitute a recommendation or endorsement of any specific investment or investment strategy. Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. It is important that investors read  Characteristics and Risks of Standardized Options before engaging in any options trading strategies.

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