An option's value, called its premium, fluctuates based on the price of the asset underlying it such as a stock, ETF or futures contract. An option contract is in the money if it has intrinsic value. Conversely, a Put option is in the money if the price of the underlying security is lower than the option contract strike price. As a brief reminder, call options are a bet that the underlying asset will rise in price, while a put option is a wager that the underlying asset price will fall.
It is called ITM because option traders are typically speculating on the price direction of the underlying asset. For example, a Call option is out of the money if the price of the underlying security is lower than the option contract strike price. Conversely, a Put contract is out of the money if the price of the underlying security is higher than the option contract strike price. It is called OTM because option traders are typically speculating on the price direction of the underlying asset.
If an option contract has the same strike price as the price of the underlying asset, the option is At the Money. Let's look at few more examples to help clarify in the money options and out of the money options. Whether an option is in the money or out of the money depends on the option's strike price and the value of the underlying security.
This difference is known as intrinsic value, but is not the only factor in the price-- premium paid--for an option. Another factor is "time value. Time value is the amount someone else is willing to pay for an option based on the probability and possibility that it will move into the money before expiry there are calculations to aid in this assessment, called " greeks ". The longer the time until expiry, the greater the time value, since there is a higher chance that over a longer period of time the option will, at some point, be in the money.
Calculating all the factors that go into the cost of an option the premium is a complex task. A simple way to think of it though is: If an option is out of the money, it has no intrinsic value, and therefore the premium is mostly composed of the time value. When you buy an option the price you pay is called the premium.
This reflects the time value, as well as any intrinsic value the option may have. Options can move in the money and out of the money, which will affect the premium, until the option expires. On the day of expiry, the option will either be in the money or out of the money, and there will no longer be any time value.
Updated July 18, In the Money An option contract is in the money if it has intrinsic value. Tying it Together When you buy an option the price you pay is called the premium.More...