In the Money and Out of the Money Options and Their Intrinsic Value

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An option contract's value fluctuates based on the price of the asset underlying it, such as a stock, exchange-traded fund, or futures contract. The option can be in the money (ITM), out of the money (OTM), or at the money (ATM). Each one of these situations affects the intrinsic value of the option.

The amount of time remaining before the option contract expires also plays a role in the value of the option, which in turn affects how high or low a price—the premium—the buyer is willing to pay for the option.

In the Money

If an option contract is ITM, it has intrinsic value. A call option—which gives the buyer the right but not the obligation to purchase an asset at a set price on or before a particular day—is in the money if the current price of the underlying asset is higher than that agreed-upon price, which is known as a strike price. The buyer could exercise their right under the option contract and buy the underlying asset for less than its current value. That means the call has intrinsic value.

Conversely, a put option—which gives the buyer the right to sell an asset at a set price on or before a particular day—is ITM if the price of the underlying security is lower than the strike price. The buyer could exercise their right under the option contract and sell the underlying asset for more than its current value. That means the put has intrinsic value.

In summary, a call option is a bet that the underlying asset will rise in price sometime before or on a particular day—known as the expiration date—while a put option is a wager that the underlying asset's price will fall during that time period.

If the strike price of a call option is $5 and the underlying stock is currently trading at $6, the option is ITM. The higher above $5 the price goes, the more ITM the option is and the greater it's intrinsic value.

If the strike price of a put option is $5 and the underlying stock is currently trading at $4, the option is ITM. The lower below $5 the price goes, the more ITM the option is and the greater it's intrinsic value.

The intrinsic value of an option that's ITM is the greater of the strike price or the price of the underlying asset minus the other price. Therefore, the intrinsic value for both the call and put options with the strike price of $5 is $1.

Out of the Money

If an option contract is OTM, it doesn't have intrinsic value. A call option is OTM if the current price of the underlying asset is lower than the strike price. The buyer of the call option would not exercise their right under the option contract to buy the underlying asset because they would be paying more than its current value.

Conversely, a put option is OTM if the current price of the underlying security is higher than the strike price. The buyer of the put option would not exercise their right under the option contract to sell the underlying asset because they would be receiving less than its current value.

If the strike price of a call option is $5 and the underlying stock is currently trading at $4, the option is OTM. The lower below $5 the price goes, the more OTM the option is.

If the strike price of a put option is $5 and the underlying stock is currently trading at $6, the option is OTM. The higher above $5, the more OTM the option is.

Because these OTM put and call options can not be exercised for a profit, their intrinsic value is zero.

At the Money

If an option contract's strike price is the same as the price of the underlying asset, the option is ATM. If the strike price of a call or put option is $5 and the underlying stock is currently trading at $5, the option is ATM. Because ATM put and call options can not be exercised for a profit, their intrinsic value is also zero.

Time Value

The value of an option consists of both intrinsic value and time value. The greater the amount of time until an option expires, the more time value it has. That's because there is a greater chance the option will, at some point, become ITM over the longer time frame before expiration and so have intrinsic value.

When deciding how much of a premium they're willing to pay, a prospective option buyer must take into consideration whether the underlying asset has or is likely to have intrinsic value and the option's time value. An option can be OTM and consequently have no intrinsic value but still have time value up until its expiration. If an ITM option has $10 of intrinsic value, the premium should be higher than $10 because of the time value inherent in the amount of time the underlying asset has to become even more ITM.

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