In the world of options trading, the term “in the money” (ITM) is a fundamental concept that every trader should understand. It refers to a situation where an option has intrinsic value, meaning the option holder can theoretically exercise the contract for a profit. Whether dealing with call options or put options, being in the money signifies that the market price of the underlying asset is favorably positioned relative to the option’s strike price.

For a call option, which gives the holder the right to buy an asset at a specified strike price, the option is considered in the money when the market price of the underlying asset is above the strike price. This means the option holder can buy the asset cheaper than its current market value. Conversely, for a put option, which gives the right to sell an asset at the strike price, the option is in the money when the market price is below the strike price. This allows the holder to sell the asset for more than its current market value.

To put it simply:

– Call option is In the Money if: Market Price > Strike Price
– Put option is In the Money if: Market Price < Strike Price

Formula:
Intrinsic Value (Call) = Max(0, Market Price – Strike Price)
Intrinsic Value (Put) = Max(0, Strike Price – Market Price)

The intrinsic value represents the amount of profit that could be realized by exercising the option immediately. It’s important to note that an option’s total premium (price) also includes time value and volatility, but being in the money strictly relates to the intrinsic portion.

Real-life example:
Consider a stock of company XYZ trading at $120. You hold a call option with a strike price of $100. Since the market price ($120) is above the strike price ($100), this call option is in the money by $20. If you exercise this option, you could buy the stock for $100 and sell it immediately for $120, realizing an intrinsic profit of $20 per share. On the other hand, if you have a put option with a strike price of $130, and the stock is at $120, this put is also in the money by $10 because you can sell the stock at $130 when it’s currently worth $120.

Common misconceptions about "in the money" options often arise around the assumption that ITM options are always profitable. While it’s true that they have intrinsic value, the total profitability depends on the premium paid for the option. For instance, if you paid $25 for the call option in the example above, even though it’s in the money by $20, you would still be at a net loss of $5 if you exercised immediately. This highlights the difference between intrinsic value and net profit.

Another common question traders ask is: "How does being in the money affect option pricing?" Generally, ITM options tend to be more expensive because they already hold intrinsic value, making them less risky compared to out-of-the-money options, which rely solely on potential future price movements. However, ITM options may have less leverage effect, meaning their price moves less dramatically with underlying asset price changes.

People also often wonder: "What happens to in the money options at expiration?" At expiration, if an option remains in the money, it typically gets exercised automatically (unless the holder chooses otherwise), and the intrinsic value is realized. If it’s out of the money, it expires worthless. This is why understanding the ITM status is crucial when managing your options portfolio near expiration dates.

To summarize, "in the money" is a key indicator of an option’s immediate value based on the relationship between the market price of the underlying asset and the option’s strike price. Recognizing when an option is ITM can help traders make informed decisions regarding exercising, selling, or holding options.