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Stock Options- In, At and Out-of-the-Money

Filed Under Advanced Options Trading 

Stock Options- In, At and Out-of-the-Money
 
An in-the-money call is any call whose strike price is less than the current stock price. If you own a May call option with a strike of $30, and the stock price is at $35, the option is in-the-money by about $5. I say “about” because you might have paid more for the option premium than the real value and you need to consider all transaction costs. As a matter of fact, if a trader hasn’t computed the breakeven of the trade, they might possibly close their position too low in-the-money and actually lose money.
 
Another way to look at being in-the-money is to imagine that if you exercise your call option today, would you make money? If you would be able to buy stock under the option contract for $30 a share and immediately sell it on the market for its current price of $35 you’d have a gross profit of $5 per share and you’d be singing “I’m in-the- money”. And, indeed, you would be!
 
Along a similar vein, a call option is out-of-the-money when the strike price is above the current price of the stock. For instance, if you purchased a May 60 call and the current price is $55, the option is out-of-the money. So, you ask yourself, “if I exercise my option and buy the stock for $60, and then sell it for $55, I would be a fool; out of your mind, out-of-the-money.
 
In-the-money calls have intrinsic and can also have some extrinsic value. An out-of-the money call has only extrinsic value. Remember, extrinsic value is time value; the probability of moving into-the-money. An in-the-money call option that has both intrinsic and extrinsic value means that even though the option is in-the-money, there is some extrinsic value because there is still time for the option to become more in-the-money and accrue more intrinsic value. When an option expires either unexercised or not closed out, both values go to zero. Not option, no value. In other words, if you happen to have intrinsic value, don’t forget to close out the position before expiration.
 
In using a premium collection strategy, the option seller wants the sold option to expire so that the premium can be kept. Of course, a sold option can be sold before expiration but that will depend on the current price of the option. To obtain an optimum return on the premium collected, the option needs to expire without being exercised.
 
An important fact is that not all options have the same exercise rules. If an option trades in the American style, an option can be exercised anytime during the option period. If an option trades in the European style, options can only be exercised after expiration. Many index options and ETFs trade the European style. Needless to say, it’s a good idea to check out what each option style is. If you are trading European style and the option moves into-the-money, you have time to get out of the position before expiration. Not so with the American style, it can be exercised as soon as the option moves into-the-money.
 
The final way to describe a type of option is when the strike and the price are close to the same; this is called at-the-money. The stock doesn’t have to be exactly at the strike price to be considered at-the-money. For instance, if you have an option with a strike at 25, the stock could be trading at $25.20, $25.50 or $24.80, $24.50 and the $25 strike will still be considered the at-the-money.
 
To learn more about all aspects of stock options, go to www.optionsuniversity.com.

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