In the Money Options Explained (Simple Guide)
If you bought a stock option, it could be “in the money.”
But what does that mean?
It means that, for the moment, the underlying stock has moved beyond the option’s strike price.
There’s a lot to unpack in that last sentence. I’ll do so in this guide.
The Strike Price
Before you can determine if an option is in the money, you have to look at its strike price.
All options, whether they’re call options or put options, have a strike price. It’s the point at which you can exercise your right to buy or sell the underlying stock.
Let’s say you buy a call option for Facebook. It expires next month and has a strike price of $143.
That means you can exercise your right to buy shares of Facebook if the stock moves higher than $143 when the contract expires.
If the stock stays below $143, there’s no point in exercising your right to buy the shares because you could just buy shares of Facebook on the open market for a lower cost.
In the Money Options and Strike Price
Once you know the strike price, you can easily determine if the option is in the money or not.
A call option is in the money when the market value of the underlying stock is higher than the strike price.
A put option is in the money when the market value of the underlying stock is lower than the strike price.
In the example above, the Facebook call option that you own becomes in the money when shares of Facebook trade for higher than $143 per share.
On the other hand, if you had purchased a $143 put option, then it would become in the money when shares trade for lower than $143 per share.
An option contract has intrinsic value when it’s in the money.
Why? Because it’s no longer speculative. The option has reached the target strike price and, for the moment, is eligible for exercise.
The intrinsic value is quantifiable. It’s the difference between the market price of the stock and the strike price.
For example, if Facebook is currently trading at $146 per share and you own a $143 Facebook call option, then the intrinsic value of the option is $3 ($146 – $143 = $3).
Keep in mind: intrinsic value isn’t constant. Just because an option has intrinsic value today doesn’t mean it will have intrinsic value tomorrow.
Stock prices are known to fluctuate.
In the Money Doesn’t Mean Profitable
You might think at this point that an in the money options contract means that the owner of the contract will earn a positive return when it expires. That’s not necessarily the case.
Let’s say that you paid $3 for that Facebook call option when the stock was trading at $142 per share. At the time of expiration, Facebook shares nudge up to $143.10 per share.
The option is in the money, but it isn’t profitable.
At the time of expiration, a $143 Facebook call option will be worth about $0.10 if the underlying stock is trading at $143.10.
Remember, though, you paid $3 for that option. Since it’s now worth just $0.10, you’re taking an enormous loss (on a percentage basis).
Also, if you were short that call option, you certainly don’t want it to go in the money. You’d rather see it drop in value.
In the Money Doesn’t Mean It’s Time to Sell
You might think that you should sell a stock option as soon as it becomes in the money. That’s not true, either.
Why? Because the underlying stock might move even more in your favor. If that happens, you could turn a higher profit.
The catch there is to watch out for time decay. Even if the stock price changes by a couple of dollars per share, time decay could still eat into your profits.
Also, you might not have turned a profit on the option just because it’s in the money (see above). It’s possible that you could still earn a positive return on the trade by waiting a little longer.
And, once again, if you’re short the option, it might not even be profitable when it’s in the money.
In the Money and Delta
Options traders evaluate options contracts with a variety of statistical measures. They’re called “the Greeks” because they’re identified with Greek letters.
One of the Greeks is delta. It measures an option’s price sensitivity relative to its underlying security.
Delta is measured as a number between 0.0 and 1.0 for call options. It’s measured as a number between 0.0 and -1.0 for put options.
Here’s how it works: if the Facebook call option mentioned above has a delta of .7, then that means the option will increase 70 cents (or .7 of a dollar) for every dollar increase in Facebook stock.
Options that are in the money have delta values that are farthest away from 0. Options that aren’t in the money will have delta values approaching 0.
In other words, you can expect an in-the-money option price to move in almost perfect sync with its underlying stock. If the stock price changes by $1, then the option price will change by about $1 as well.
In the Money and Covered Calls
If you own shares of a stock and you’d like to generate some cash, you can do that by writing a covered call option.
In that case, you sell somebody else the right to purchase your shares of stock at a specific price at some point in time.
As you might have guessed, that “specific price” is the strike price.
If your stock hits that strike price at expiration, you can expect the person who purchased the option from you to exercise his or her right to buy the shares. In that case, you’ll sell the shares for the strike price.
You won’t have to worry about losing your shares if the stock never hits that strike price, though.
So if you want to keep your shares, plus the money you earned from selling the call option, then you don’t want that option to go in the money. You’d prefer that the underlying stock stay below the strike price.
On the other hand, if you’d like to sell your shares of stock for a little bit more than what the market is paying, you can write a covered call option and wait for it to go in the money.