In The Money: Options Contracts

Detailed explanation of 'In The Money' options, including definitions for call and put options, calculations, examples, historical context, and FAQs.

In The Money (ITM) refers to an options contract that has intrinsic value. For a call option, this occurs when the stock’s current market price is above the striking price. Conversely, for a put option, this situation arises when the stock’s current market price is below the striking price.

Call Option In The Money

A call option is said to be In The Money (ITM) if the current price of the underlying stock is above the striking price:

$$ \text{Call: } P_{current} > P_{strike} $$

Put Option In The Money

A put option is considered In The Money if the current price of the underlying stock is below the striking price:

$$ \text{Put: } P_{current} < P_{strike} $$

Calculations and Examples

Call Option Example

Consider a call option with a strike price of $50. If the current market price of the stock is $55, the call option is ITM. The intrinsic value of this call option can be calculated as:

$$ \text{Intrinsic Value} = P_{current} - P_{strike} = 55 - 50 = \$5 $$

Put Option Example

For a put option with a strike price of $50, if the current market price of the stock is $45, the put option is ITM. The intrinsic value in this case is:

$$ \text{Intrinsic Value} = P_{strike} - P_{current} = 50 - 45 = \$5 $$

Historical Context

The concept of options dates back to the ancient Greek and Roman markets, but modern options trading gained prominence in the 1970s with the establishment of the Chicago Board Options Exchange (CBOE). Understanding whether an option is ITM is crucial as it directly impacts the payoff at expiration.

Applicability

Knowing when an option is ITM is essential for traders and investors for several reasons:

• Risk Management: Helps in analyzing potential gains or losses.
• Trading Strategies: Influences decisions regarding exercising options, selling, or holding them.
• Pricing Models: Central in various options pricing models, such as the Black-Scholes model.

Comparisons

In The Money (ITM) vs. At The Money (ATM)

• In The Money (ITM): Options with intrinsic value.
• At The Money (ATM): Occurs when the option’s strike price is equal to the current price of the underlying asset.

In The Money (ITM) vs. Out of The Money (OTM)

• Out of The Money (OTM): Options with no intrinsic value. For call options, if the stock price is below the strike price, and for put options, if the stock price is above the strike price.

Related Terms

• Strike Price: The set price at which an option can be exercised.
• Intrinsic Value: The actual value of an option if it were exercised today.
• Premium: The price paid for purchasing the option.

FAQs

Why does being In The Money matter in options trading?

Being ITM determines if exercising the option will result in a profit, making it a critical factor in decision-making for traders.

Can an option that is In The Money expire worthless?

No, an ITM option does not expire worthless. If it isn’t exercised, it generally results in a payoff that reflects its intrinsic value.

References

1. Hull, John C. “Options, Futures, and Other Derivatives.” Pearson Education, Inc.
2. Black, Fischer, and Myron Scholes. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 1973.

Summary

In The Money (ITM) is a key concept in options trading that signifies when an option has intrinsic value. It is determined by comparing the underlying stock’s current market price with the option’s strike price — higher for call options and lower for put options. ITM status influences trading strategies, potential returns, and risk management, making it essential for traders and investors to understand and monitor.