30 Jun 2017
An option is in-the-money (ITM) when it gives the holder a positive result in case of immediate option execution. ITM indicates that the spot price of underlying shares is higher than the option strike price when it comes to call options and lower for puts.
For the identification of options, the purpose of which lies in the comparison of the option exercise and the underlying asset prices, we can emphasize 3 main groups:
- in-the-money (ITM)
- out-of-the-money (OTM)
- at-the-money (ATM)
Talking about calls, «in-the-money» can be determined when: Asset price > Call strike price
Talking about puts, «in-the-money» can be determined when: Asset price < Put strike price.
We can apply another term called intrinsic value to demonstrate the extent the option is in-the-money.
If an option is not ITM at expiration, in other words it’s intrinsic value equals zero, the contract is considered worthless.
Let’s take the following example: the call option has the strike price of $90 and the current asset price is $115. It indicates that the option is ITM, that is at a profit, since after buying this contract for $115 and its immediate selling for $90, the intrinsic value equals $25.
There are also terms that specify the degree or depth. For instance, an option with a large profit is usually called deep in-the-money. Accordingly, options with a large loss are called deep out-of-the-money. This concludes that the option contract under consideration has more distant exercise price than the current price of our asset in comparison with another contract.
Suppose, the strike price of the call is $90 and if the price of the asset is $115 and we say this contract is in-the-money, then another call with the strike of $85 provided the maintenance of the same underlying asset price can be called deep ITM. At the same time the option with the same strike and higher stock price (let’s say, $125) will be also deep ITM, since this option can benefit more than the first one.
The deeper the option in-the-money is, the more its intrinsic value is and, respectively, the higher its cost to the share price is.