An ITM, or In The Money, is a term used in options trading to describe an option contract where the underlying asset's price is higher than the strike price for a call option or lower than the strike price for a put option.
Understanding ITM Options
- Call Option: A call option gives the holder the right (but not the obligation) to buy an underlying asset at a specific price (the strike price) on or before a certain date (the expiration date). If the underlying asset's price is higher than the strike price, the option is ITM and the holder can exercise the option to buy the asset at a lower price than the market price, making a profit.
- Put Option: A put option gives the holder the right (but not the obligation) to sell an underlying asset at a specific price (the strike price) on or before a certain date (the expiration date). If the underlying asset's price is lower than the strike price, the option is ITM and the holder can exercise the option to sell the asset at a higher price than the market price, making a profit.
Example:
Let's say you buy a call option for 100 shares of Apple stock with a strike price of $150. If the current market price of Apple stock is $160, the option is ITM because the underlying asset's price ($160) is higher than the strike price ($150). You could exercise the option and buy the 100 shares of Apple stock at $150 per share, then immediately sell them in the market at $160 per share, making a profit of $10 per share.
Importance of ITM Options
- Profit Potential: ITM options have a higher probability of making a profit compared to out-of-the-money (OTM) options.
- Time Value: ITM options have a smaller time value compared to OTM options. This means that the premium paid for an ITM option is mostly intrinsic value, which is the difference between the strike price and the underlying asset's price.
- Higher Risk: ITM options are more expensive than OTM options, meaning there is a higher risk of losing money if the underlying asset's price drops.
