In the Money Option Contracts: What to Know and How to Get Started

What does In the Money Option Contracts Mean, Exactly?

In the money option contracts, also known as “ITM,” are contracts that have positive intrinsic value. You can determine if the intrinsic value is positive by taking the difference between the strike price and the current market price of a stock.

Imagine you purchase a call option with a strike price of $90, on a stock that is trading at $100. If the stock price rises to $110 before the expiration date of the contract, the contract is considered in the money because the intrinsic value is $20… $110 minus $90 equals $20.

On the other hand, if the contract loses intrinsic value if the price of the stock goes below $90, because it is now considered out of the money (OTM).

How Does In the Money Option Contracts Work?

In the money (ITM) option contracts work in this manner:

1. A buyer pays the premium: The buyer (investor or trader) pays a premium for the option contract to the seller.
2. Option holder has a profit: The trader or investor can sell or exercise their ITM option contract for a profit if the stock price moves in their favor.
3. Seller has an obligation (optional): If the trader or investor decides to exercise their option, the seller has the obligation to sell or buy the stock at the agreed strike price.
4. Options can be sold (optional): Instead of exercising the option contract, the trader or investor can sell their option contract to another party for profit.

Pros and Cons

In the money (ITM) options offer several advantages such as reduce risk, and higher probability of profit.

Pros

• Higher delta: As options get deeper in the money, the delta value rises giving the contracts a higher premium value.
• Reduce risk: In the money option contracts are less risky because they have intrinsic value, and it reduces theta.

Cons

• Higher premiums: In the money options have cost more because they have intrinsic value.
• Lower potential gains: Because ITM has intrinsic value, traders have the possibility to making lower returns.

Risks that Come with In the Money Option Contracts?

Even though in the money (ITM) options are less risky, they’re still options, and options come with risks.

• Theta also known as “time decay”: Even though in the money options have intrinsic value, and theta reduces drastically, it doesn’t get rid of it. Allowing your option premium to drop.
• Turning into out of the money (OTM): In the money options are still at risk of having the stock price go against your strike price, thus losing intrinsic value and making your contracts lose premium.
• Lower returns: The less risk involve the less percentage returns.
• Higher premium cost: With less risk, it also means it’s more expensive then your out of the money (OTM) options.

Are In the Money Option Contracts Right for You?

If you’re trying to get the highest gains to show off to your followers, in the money (ITM) options may not be for you. But if you’re the type of trader who will trade high risk for low risk, and a higher probability of coming out profitable, then in the money (ITM) options may be the right choice for you.

To Sum It Up

In the money option contracts come with disadvantages such as higher premiums, lower returns. But the trade offs may be well worth it as it provides higher delta, and reduces risk because it has intrinsic value and theta is reduced. It’s important for you as the trader to consider these factors before entering these types of contracts.

Other Asked Questions

Are ITM Calls Always Exercised?

In the money (ITM) options are not always exercise. It may make more since to sell the options, because it may give you a higher profit return. But this really depends on the traders goals and strategies.

What Happens When you Exercise an ITM Put Option?

If you exercise a in the money (ITM) option contract, you have the right to sell the stock at the strike price that you chose.

Imagine you have a ITM put option with a strike price of $40, the market price of the stock is $35. If you exercise your ITM put option contract you can make a profit of $5 per share.

Before considering to exercise your ITM put option, make sure you look at other options as it may make you a higher return.

What Happens if Options Expire In the Money (ITM)?

When your option contracts expire in the money (ITM), they will automatically be exercised. For example, if you have a put option you will have a new short position in your brokerage account, and if you’re in a call option, you will have a long position in your account.

You need to be aware of this next thing I say, if you do not have the funds in your account to cover the cost of the exercise, you may be charged with additional fees or get penalties. So, keep an eye on your option positions before they expire.