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In-the-Money Options: What You Need to Know

What are in the money options?


"In the money" (ITM) options are a type of financial contract that gives the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price, known as the strike price. An ITM option is one where the market price of the underlying asset is currently higher than the strike price of the option (in the case of a call option) or lower than the strike price (in the case of a put option).

(Source:OptionBros)


ITM options are considered to be more valuable than out of the money options because they have an intrinsic value. The intrinsic value is the difference between the market price of the underlying asset and the strike price of the option. For example, if a call option has a strike price of $50 and the underlying asset is currently trading at $60, the intrinsic value of the option is $10.


How do in the money options work?


When an investor buys an ITM call option, they are hoping that the price of the underlying asset will continue to rise above the strike price of the option. If the price of the underlying asset does rise, the investor can exercise the option, buying the asset at the lower strike price and selling it on the market at the higher market price, realizing a profit.


On the other hand, if the investor buys an ITM put option, they are hoping that the price of the underlying asset will continue to fall below the strike price of the option. If the price of the underlying asset does fall, the investor can exercise the option, selling the asset at the higher strike price and buying it back on the market at the lower market price, realizing a profit.


Why do investors use in the money options?


Investors use ITM options as a way to hedge against market fluctuations and to make speculative investments with a potentially high return. By buying an ITM option, investors are able to limit their potential losses while still benefiting from the potential gains.


For example, if an investor believes that the price of a particular stock is going to rise, they could buy an ITM call option instead of buying the stock itself. If the price of the stock does rise, the investor can exercise the option and buy the stock at the lower strike price, realizing a profit. However, if the price of the stock does not rise as anticipated, the investor can limit their losses by not exercising the option.


Similarly, if an investor believes that the price of a particular stock is going to fall, they could buy an ITM put option instead of short selling the stock itself. If the price of the stock does fall, the investor can exercise the option and sell the stock at the higher strike price, realizing a profit. However, if the price of the stock does not fall as anticipated, the investor can limit their losses by not exercising the option.


Conclusion


In conclusion, "in the money" options are a powerful tool that investors can use to hedge against market fluctuations and to make speculative investments with a potentially high return. Understanding how they work and why investors use them is important for anyone who wants to invest in the stock market.



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