In-Depth Guide to In-the-Money (ITM) Options: From Definition to Profitable Trading
The term "in-the-money" is basically the entry point into options trading. An in-the-money option (ITM) is an options contract that already has value at the time that it is opened. If this same action took place now, then you would make money if you were to exercise that particular option.
An in-the-money option has a different definition based on its type. An option is classified as ITM if the underlying stock price is above the strike price for call options. For example, your call option has a strike price of $150, and the stock is currently trading at $160; therefore, your call option is ITM by $10. Opposite in this scenario for put options, if the stock price is below the strike price, then your put option is ITM.
ITM Option Pricing: Breaking Down Intrinsic and Time Value
For instance, in our example of Microsoft with the stock trading at $445 and you owning a $430 call, you would have an intrinsic value of $15. If you were to exercise the call option today, there is $15 already in the bank for you.
The time value of an option is the additional premium you are paying for the potential that your option may become more profitable prior to expiration. The amount of time left until expiration, the volatility of the stock and the expectations of the market all contribute to how much time value an option has.
How to Identify High-Potential ITM Options
The process of identifying the proper In-The-Money (ITM) option doesn't simply revolve around deciding on any strike below the current price of the underlying security. You will want to also take into consideration liquidity, volatility and overall strength of the trend as well.
Use the option chain to help find available opportunities. A list of all available strikes and expiries will be found on any broker's desktop or app, showing the strike prices to be found on each contract, along with the respective expiration date, as well as all active volume information and open interest information.
Delta Explained: How It Drives ITM Option Profits
A Delta value of 0.75 means that if the stock rises $1, your option's value will increase by approximately $0.75. A Delta value of 0.50 is typical of an At-the-Money (ATM) option; hence, for every $1 movement in stock price, the option value would increase by $0.50. Options that are Out-of-the-Money (OTM) generally have a lower Delta than ATM options, typically in the range of 0.20 to 0.30.
Delta is important for In the Money (ITM) options because as you go deeper into ITM, the delta increases. For example, a deep ITM call may have a delta of approximately 0.90-1.00, which means that it will track nearly dollar for dollar with the stock. Therefore, you can get stock-like exposure to AAPL with much less capital at risk.
ITM Trading Strategies: Low-Risk, High-Reward Plays
ITM (In-The-Money) Calls or Puts: You can purchase ITM (In-The-Money) Calls or Puts if you are bullish on Tesla. If you think TSLA will go up in price, an example of an ITM Call Option is a $380 Call option (ITM) vs. $420 Call option (OTM). Although an ITM call will cost more than an OTM call, and an ITM call has a higher probability of staying profitable at expiration than an OTM call.
Protective Puts: You can use Protective Puts to protect against declines in the market. Assume you own 100 shares of AAPL at $235 and wish to protect that investment from losses due to market corrections. You can buy an ITM Put (currently at $240) to protect against downside losses. Selling your stock at $240 is possible regardless of the price decline.
Advanced ITM Techniques: Greeks and Portfolio Management
You can use multiple contracts your return simultaneously, for example: You purchase an AAPL $220 CALL option (ITM) and sell two AAPL $240 CALL options (OTM) - this strategy is called a ratio spread. You are long one ITM call and short two OTM calls. If AAPL trades between the $220 -$240 range, you will capture the time decay on your short calls. If AAPL rallies above $240, your profits are capped, but you will still profit.
To successfully use these strategies, strict risk management must be applied. Establish position limits. Do not risk more than 5% of your portfolio on one trade and consistently use stop-losses. Monitor your Greeks daily to avoid the surprise of an adverse move.
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