Watch our video on how in the money options contracts work when trading options. These types of options are safer to trade then their brothers and sisters. Find out why. (Seriously you need to know this)
What Does In the Money (ITM) Mean With Options?
- In the money refers to the strike price of an options contract and where the price is in relation to the market. In the money is when a call's strike price is lower than the market price. An in the money put means that the strike price is above the market price.
In the money is one of the three "money" components to options trading. The video above explains how it works when purchasing an options contract.
In the money (ITM) options contracts are seen differently depending on if they're calls or puts.
Options trading gives you the right but not the obligation to buy (call) or sell (put) a stock at a specified price. Read our post on put and call options explained to learn more about the contracts that make up options trading.
There are many moving parts to options trading. Those moving parts can affect both profit and loss. Hence the need to make sure you've studied and practiced paper trading options a lot.
1. Basics of In the Money
Any in the money options contracts, whether bullish or bearish, mean that there's intrinsic value.
Strike prices are made up of intrinsic and extrinsic value. There are three different types moneyness options contracts; in the money, at the money and out of the money. As a result, out of the money contracts have no intrinsic value.
Just another part of options trading where profit and loss is affected. Hence the strike price is one of, if not the most important part of picking an contract to buy.
Being in the money doesn't mean you'll make a profit. However, it does give you a much chance. The contract has intrinsic value, therefore it's worth exercising.
For example, you purchase a call at $10. The stock is currently trading at $14. That call options is considered to be in the money. In essence, you could sell it for a gain of $4.
Each options contract controls 100 shares. So you'd multiply 4 x 100 and it comes to $400. Another great things about options contracts is that they're not as expensive as buying shares outright.
2. How Options Contracts Work
In the money options contracts for calls are lower than the market price. This makes them more expensive to buy. That's not necessarily a bad thing as it's still cheaper than buying 100 shares of a stock.
In the money options contracts tend to be the safer bet if buying naked calls and puts. Hence why they cost more than at or out of the money. Options contracts do expire. The time value is also known as extrinsic value.
This also affects the profit and loss of a contract. An in the money options contract with a short expiration date will be cheaper than one that's 1-2 months out. However, the more time value there is, the higher the chance of making a profit.
A put option that's in the money, has a strike that's higher than the market price. Put options are the bearish option and the equivalent to short selling. You can both buy and sell put options.
3. Direction Matters
The direction of the stock matters a lot when using options trading strategies. As a result of all the effecting parts, the wrong direction can be detrimental to profit. That means you should take the time to learn candlesticks and patterns.
Buying put options on an inverse head and shoulders breakout is a bad move. You'll most likely lose the premium you paid. If you paid $624 for put options and it doesn't reverse, you'll most likely lose the $624.
Patterns are so important. They provided potential direction whether it's a reversal or a continuation of a current trend. They also provide support and resistance. That happens to be some of the most important levels in trading. Knowing how to sell options helps with needing to know the immediate direction.
Whether you're using candlesticks or fibonacci levels to find support and resistance, you have to pay attention to where they are. You can also look at open interest on the options chain to see if other traders share the same view.
The more open interest there is, the more confirmation there can be as to a direction. Implied volatility is also an important aspect to your profit or loss. The more volatility, usually the more in the money an option will move.
This is more risky but also gives you a higher chance of profitability (check out our swing trading strategies page).
4. Technical Analysis: In the Money
Technical analysis is another way to find direction. You can use moving averages, parabolic sar or on balance volume to get a feel for a stocks direction. Technical indicators are there as tools for you to use.
There's no magic formula that'll tell you where a stock's heading. However, these tools coupled with patterns and candlesticks can give you a clearer picture. Not every trade is going to be a winner.
Use technical analysis with candlesticks and patterns as confirmation to get out of a trade. They help to take the emotion out of trading. Take our options trading course.
The Bottom Line
In the money options contracts are the most popular contracts to trade. They can give you a cushion but you need the time to make sure it's the right trade. Options have many moving parts. Make sure to take the time to study how stock options work as well as practice trading them. Once they're been mastered, they're a great strategy to use.