Options: What are In the Money-ITM and Out of the Money-OTM?

Options are contracts through which a seller gives a buyer the right, but not the obligation, to buy or sell a specified asset (Ex: Foreign currency, shares, equities, commodities etc.) at a predetermined price, by a certain date. It means they acquire or dispose of the underlying asset at that price called the strike price. Options come with an upfront fee cost—called the premium—that investors pay to buy the contract. In case of lapse of option, only option money or premium, which is initial purchase money of the option, is lost.

Options are two types. 1. Call option.   2. Put option. Call option means the option of the buyer to buy an asset at a specified price and time. Put option means the right of a seller to sell an asset at a specified price and time.

Options are further distinguished as “in the money,” “out of the money “or “at the money”.

In the money (ITM) is a term associated to an option contract. ITM indicates that the option has value in a strike price favorable in comparison to the prevailing market price of the underlying asset. Through the ‘in-the-money call option’ the option holder has the opportunity to buy the security below its current market price. Similarly, ‘in-the-money put option’ refers to the option holder who can sell the security above its current market price.

In the other words;

A call option is in the money (ITM) if the market price is above the strike price.

A put option is in the money (ITM) if the market price is below the strike price.

For example, if the strike price of a call option is Rs.25, and the underlying stock is currently trading at Rs.26.20, that option is in the money (ITM). The buyer of the call to make significant money when the price starts rising above Rs.25.  On the other hand, a Put option is in the money if the price of the underlying security is Rs.24.10 which is lower than the option contract strike price of Rs.25.

We may therefore conclude that the call options are a gamble that the underlying asset will rise in price, while a put option is a gamble that the underlying asset price will fall.

In case of OTM (Out Of the Money), placement is exactly the opposite of in the money. Out of the money indicates a call option with a strike price that is higher than the market price of the underlying asset, or a put option with a strike price that is lower than the market price of the underlying asset.

For example, if the strike price of a call option is Rs.25.20, and the underlying asset is currently trading at Rs.24.70, that option is out of the money. A put option with a strike price of Rs.23.20 that is lower than the market price of Rs.24.70 then the underlying asset is Out of the money.

ATM (At the Money) is an additional term used for describing a tie where the closing asset price is identical or closer to the entering price. For example entering price of an asset is Rs.25/- and closing price is Rs.25.05 which is almost a tie. It means placement will not return a profit. This is known as At the Money (ATM) option.