What does “In The Money” mean in options trading?
When we talk about options trading, the term “In The Money” (ITM) refers to the situation where an option has moved beyond its strike price, giving it an intrinsic value greater than zero. The concept of ‘moneyness’ essentially describes the relationship between the current price of the underlying asset and the strike price of the option. An option is considered ITM if it has intrinsic value, which means it can be exercised profitably.
How does “In The Money” apply to call and put options?
For a call option, being ITM means that the exercise price is below the current price of the underlying asset. For instance, if you hold a call option on a stock with a strike price of $250 and the current market price is $300, your option is ITM because you can buy the stock at $250 and sell it immediately at $300, making an instant profit. On the other hand, a put option is ITM when its exercise price is above the current market price. For example, if you have a put option with a strike price of $350 and the stock is currently trading at $300, the option is ITM because you can sell the stock for $350 when it’s only worth $300 in the market.
What happens if the asset price does not exceed the strike price?
If the asset price does not go beyond the strike price, the option is said to be “Out Of The Money” (OTM). This means the option has no intrinsic value and would not be profitable to exercise. Conversely, if the asset price equals the strike price, the option is “At The Money” (ATM). Ideally, traders aim for their options to be ITM upon expiration to ensure they are profitable. An option that is not ITM at expiration will expire worthless, meaning the trader loses the premium paid for the option.
Does “In The Money” guarantee a profit?
While being ITM means that an option has intrinsic value, it does not guarantee a profit. The profitability of an option also depends on the premium paid to purchase it. For an option to be profitable, the intrinsic value must exceed the premium paid. For example, if you paid a $60 premium for an option that is ITM by $50, you would still incur a $10 loss. Therefore, traders must consider both the intrinsic value and the premium when determining the potential profitability of an ITM option.
What factors influence the premium of an ITM option?
The premium of an ITM option can be influenced by several factors. Firstly, if an option is already ITM, the premium tends to be higher because the option has intrinsic value. Secondly, the likelihood of the option becoming ITM can also drive up the premium. For instance, during periods of high volatility, there’s a greater chance that the option will move ITM, leading to a higher premium. Additionally, options with longer expiration dates typically have higher premiums due to the increased time value, providing more time for the option to move further ITM.
Can you provide an example of an ITM option?
Let’s say shares of company ABC are currently trading at $300 per share. If you hold a call option with a strike price of $250, this option would be ITM. The intrinsic value would be $50 ($300 – $250), meaning you could buy the shares at $250 and sell them immediately at $300. Alternatively, if you purchased a put option on ABC’s shares with a strike price of $350, it would also be ITM. You could sell the shares at $350 while they are worth only $300, giving the option an intrinsic value of $50. However, to achieve profitability, the trade must move further ITM to cover the cost of the premium paid for the option.
How can you build your trading knowledge?
To effectively trade options and understand concepts like ITM, it’s crucial to build a solid foundation in trading knowledge. Educational resources such as IG Academy offer interactive courses, webinars, and seminars that can help you grasp the intricacies of options trading. By engaging with these resources, you can learn about strike prices, expiration dates, and other essential aspects of trading, enhancing your ability to make informed decisions and potentially achieve better trading outcomes.
