In the Money Option (ITM)

In the money option contract has intrinsic value, which means exercising at the in-the-money strike price will result in profit. In the money contracts, both call and put have a higher premium.

Understanding In The Money Option

Understanding in-the-money (ITM) options is simple when you break it down. These options work differently for call and put options.

For a Call Option (ITM): Stock Price > Strike Price

A call option becomes In-the-Money when the market price of the stock rises above the strike price. This means the option holder can buy the stock at a lower strike price and potentially sell it at the higher market price, creating intrinsic value.

For a Put Option (ITM): Stock Price < Strike Price

A put option becomes In-the-Money when the market price of the stock falls below the strike price. This allows the option holder to sell the stock at the higher strike price while the market price is lower, giving the option intrinsic value.

Being in the money means the option already has some value, called intrinsic value. This is because if you exercise the option right now, you will make a profit. Since ITM options have this guaranteed value, they are less risky compared to options that are out of the money (OTM) or at the money (ATM). That is why ITM options have higher premiums.

Apart from intrinsic value, every option also has a time value. Time value is the extra cost you pay for the chance that the stock price could move even more in your favour before the option expires.

So, the premium of an ITM option is made up of intrinsic value and time value. Because these options already have some profit built in and lower risk, their price is higher compared to OTM or ATM options.

Here is the Nifty option chain, which is currently trading at 22,830. Here, call ITMs are 22,800,22,750, and put ITMs are 22,900,22,950,23,000.

Role of Strike Price in ITM Options

The Strike price determines whether an option contract becomes In-the-Money (ITM).

For a call option, the contract turns ITM when the market price rises above the strike price. For a put option, the option becomes ITM when the market price falls below the strike price.

The larger the gap between the market price and strike price, the greater the intrinsic value of the option.

Benefits Of Trading ITM Options

Many beginners get attracted to cheap OTM options, hoping for big profits, but these often expire worthless. This is why experienced traders prefer ITM options, as they offer better chances of profit and lower risk.

ITMs have a High Probability of Exercise.

Due to the intrinsic value of ITMs, they are already in favour of the option buyer. Since the ITM option is already in profit, there is a higher chance that it will stay profitable or improve further before expiry.

Let’s say the stock price is ₹150, and you buy a Call Option with a strike price of ₹130.

Since the stock is already ₹20 above the strike price, there’s a good chance it will stay above ₹130 or even go higher.

Compare this to an OTM option, like a Call with a strike price of ₹170. The stock must move ₹20 up just to break even, which is less likely.

Lower Risk Compared to OTM Options

ITM options are considered less risky because they already hold some value. Even if the stock doesn’t move much, the intrinsic value protects part of your premium.

A call option with a ₹130 strike price is bought when the stock is at ₹150. If the stock stays at ₹150, exercising the option results in a ₹20 profit. But a call option with a ₹170 strike price (OTM) expires worthless if the stock stays at ₹150.

When Should You Prefer ITM Options?

Knowing when to pick ITM, OTM, or ATM can make a big difference in returns.

Buying ITM options is more suitable when the goal is a safer, more reliable return and the stock is expected to move steadily in the expected direction. When there is a strong conviction of underlying moves in the same direction, and a notion to avoid losses because ITM options have intrinsic value.

Here is a table summarising the impact of profitability and risk level of all the option contracts.

In the money option vs out of the money option

Conclusion

ITM options are a good choice for traders who want lower risk and more stable returns. They already have intrinsic value, which gives them a better chance of making a profit compared to OTM options. Because of this built-in value, ITM options are less likely to expire worthless, making them suitable for traders who prefer safer trades.

Although ITM options cost more because of their higher premiums, they offer more security, especially when the market moves slowly or as expected. This reduces the risk of losing the entire premium, which is a common issue with OTM options.

Choosing between ITM, OTM, or ATM depends on the trading goal and risk level. ITM options work best for steady market expectations, while OTM suits high-risk, high-reward strategies.

Frequently Asked Questions (FAQs)

What is In the money option?’

An In-the-Money (ITM) option is an option contract that already has intrinsic value because the market price has moved favourably compared to the strike price.

For a call option, the market price is above the strike price, while for a put option, the market price is below the strike price.

Why ITM Options Have Intrinsic Value

Intrinsic value represents the built-in profit already present in an ITM option contract.

For example, if a stock is trading at ₹1,500 and a call option has a strike price of ₹1,450, the option already carries an intrinsic value of ₹50. This built-in value is why ITM options generally have higher premiums than ATM or OTM contracts.

What happens when an option expires in the money?

When an option expires In the Money, it generally results in settlement or exercise of the contract. Depending on the type of option and exchange settlement rules, the trader may receive profits through cash settlement or physical settlement of the underlying asset.

How to calculate potential gains from in-the-money options?

Potential gains from ITM options are calculated by comparing the difference between the market price and the strike price after adjusting for the premium paid.

For a call option:

For a put option:

If the result is positive, the trader earns a profit. If the option expires without sufficient price movement, losses are generally limited to the premium paid.

Is it better to buy ITM or OTM options?

ITM options are better for safer, steadier returns because they already have value and are less likely to expire worthless. OTM options are cheaper but riskier, as they often expire with no value. ITM is good for lower risk, OTM for higher risk and reward.

What are the benefits of ITM options?

ITM options have a higher chance of profit because they already hold value. They are less risky and can still be worth something even if the stock price doesn’t move much. This makes them a safer and more reliable choice.