Welcome back, option traders!
Today's topic is something fundamental that option traders need to understand. And because of the similar terms used, it can be confusing when you hear In-the-Money and Out-of-the-Money.
What exactly do you mean by that?
What is In-The-Money (ITM) vs. Out-of-The-Money (OTM)?
When trading options, understanding whether an option is In-The-Money (ITM) or Out-of-The-Money (OTM) is critical to knowing its current value and potential for profit.
In-The-Money (ITM):
An option is considered In-The-Money when it has intrinsic value. For calls, this means the stock’s price is above the strike price. For puts, it means the stock’s price is below the strike price.
Call Option ITM Example:
If you hold a call option with a strike price of $100, and the stock is trading at $110, the option is In-The-Money by $10. You have the right to buy the stock at $100 and sell it at the current market price of $110, locking in a profit.
Put Option ITM Example:
If you hold a put option with a strike price of $100, and the stock is trading at $90, the option is In-The-Money by $10. You can sell the stock at $100, even though it’s currently trading lower at $90, making the option valuable.
Key Takeaway:
ITM options are valuable because they are immediately exercisable for a profit. However, they are more expensive to buy and offer lower premiums when sold since they are closer to being exercised.
Out-of-The-Money (OTM):
An option is Out-of-The-Money when it does not have intrinsic value. For calls, this means the stock’s price is below the strike price, and for puts, the stock’s price is above the strike price.
Call Option OTM Example:
If you hold a call option with a strike price of $100, and the stock is trading at $90, the option is Out-of-The-Money. You wouldn’t want to exercise your right to buy the stock at $100 when it’s available for $90 on the open market.
Put Option OTM Example:
If you hold a put option with a strike price of $100, and the stock is trading at $110, the option is Out-of-The-Money. No one would want to sell the stock at $100 when it’s trading higher at $110.
Key Takeaway:
OTM options have no intrinsic value and are generally cheaper to buy, making them popular for buyers looking for leverage. For sellers, OTM options generate higher premiums with a lower probability of being exercised, which is why they are great for strategies like selling cash-secured puts or covered calls.
Understanding the difference between ITM and OTM is crucial for deciding how much premium you’ll collect, your probability of assignment, and how to manage your risk effectively. Whether you’re selling high Delta or low Delta options, knowing if you’re ITM or OTM is key to executing a successful trade.
That’s it for now, folks!
Keep your trades smart, stay patient, and as always—happy trading!
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