Call options serve as an excellent short-term alternative for acquiring equities that aren’t intended for long-term portfolio retention. Additionally, they can play a vital role in a well-balanced investment portfolio. By investing a small fraction of the capital, you have the potential to secure similar gains as with stock purchases. The flexibility to terminate the trade at any point or let it run until expiration provides an added advantage. This approach allows you to showcase substantial gains by conserving funds instead of utilising them all at once, challenging the notion that spending money is a prerequisite for generating profits. One of the key classification terms in the realm of options is in-the-money (ITM). In this context, we’ll delve into the details of in-the-money call options, exploring what they entail, along with their advantages and disadvantages.
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Understanding In-the-Money Call Option
There are three option moneyness states, including in-the-money options. Out-of-the-money options and at-the-money options are the other two option states.
- Transacting in-the-money is actually what trading novices should go with. It is relatively less risky and can still offer a decent profit. Options that may be exercised to buy the underlying stock for less than the current market value or to sell the underlying stock for more than the current market price are referred to as in-the-money options. Share India’s options calculator is also a great way to test different trading strategies and what results they would yield.
- An out-of-the-money option refers to a situation where the current market price of the underlying asset is not favourable for the option holder’s profit. For a call option, it means the underlying asset’s market price is below the option’s strike price. In the case of a put option, the underlying asset’s market value is higher than the put option’s strike price.
- An at-the-money option occurs when the current market price of the underlying asset is equal to the option’s strike price. In other words, the option has not yet moved into a profitable position for the holder.
Advantages of In-the-Money Call Option
- A call option buyer who is currently ITM at expiry may make money if its market price is higher than the strike price.
- An investor with a put option that is ITM can make money if the market price drops below the strike price.
- ITM calls have a delta (representing the option’s sensitivity to changes in the underlying stock price) closer to 1, so they move more in line with the underlying stock price. This provides greater leverage compared to out-of-the-money calls.
- There is a higher probability of an ITM call option expiring in profit compared to OTM options. The option has intrinsic value built in.
- ITM calls can be exercised by the buyer anytime before expiry to capture the intrinsic value. This provides flexibility.
Disadvantages of In-the-Money Call Option
- Options in-the-money are more expensive than options as investors have to pay for the contract’s profit.
- Investors must also factor premium and commission fees into their profitability calculations of an in-the-money option.
- The higher premium results in lower leverage compared to OTM calls. Less capital is freed up for other opportunities.
- Time decay accelerates as options move deeper into ITM, reducing value faster as expiry approaches.
- Profit is capped at the strike price plus the premium paid. Lower potential for multiplication of returns compared to OTM calls.
An Example of In-the-Money Option
Say, ABC Company Ltd.’s shares are now selling at ₹750 each. When a call option has a ₹650 strike price, it is considered to be currently ITM since the option holder has the choice to buy the option and immediately sell it for ₹100. In this case, the intrinsic value of the option is ₹100.
In other circ*mstances, if a put option is purchased on the company’s shares and has a ₹800 strike price, it would again be ITM since the option holder would have the ability to buy an option and then sell it immediately for ₹800. The option will be worth ₹100. The transaction, however, will need to go deeper into the money in order to be profitable in case the option is ITM during purchase.
How Being In-the-Money Affects an Option’s Premium
The moneyness of an option, or whether it is ITM, ATM, or OTM affects the option’s premium. An option is considered ITM if the current stock price is favourable for the holder to exercise the option and realise a profit. An ITM option generally has a higher premium compared to an OTM option, as the holder is more likely to exercise it and realise a profit. An ATM option has a premium that is somewhere between ITM and OTM options. The exact premium depends on various factors, such as volatility, time to expiration, and interest rates.
What Happens When Options Expire In-the-Money?
The call option buyer has the choice, but not the responsibility, to buy the specified number of shares of a stock at the call option’s strike price. The obligation to sell a specified number of shares of the underlying asset at the option’s strike price is placed on the seller of a call option, which expires ITM. You can terminate the transaction before expiration or move it to a later expiration cycle to avoid being assigned.
Conclusion
In conclusion, an in-the-money call option is a financial instrument where the current market price of the underlying asset surpasses the call option’s strike price. This favourable scenario, often accompanied by a higher delta approaching 1, signifies a strong link between the option’s value and the underlying stock price. ITM call options are prized for their increased probability of profitability and heightened responsiveness to stock price fluctuations, providing investors with a strategically advantageous position within the options market.
Frequently Asked Questions (FAQs)
What are ITM call options?
If the existing price of a stock is trading at a price higher than the strike price of the call option, it’s said to be ITM. We refer to it as ITM call options, as the trader has the right to buy them below the stock’s market price.
What occurs on exercising a call option prior to its ITM expiration?
An ITM call option does not legally ‘expire’ because they are often executed before expiration. The trader either exercises the call option and buys the underlying stock at its strike price or sells the option to another trader who wants to execute it if it is ITM on the expiration day. A program that streamlines this process on the expiration date upon market close may be available through your brokerage, so check to see if it is available.
Why will an ITM call cost you money?
An ITM option costs you more money than other options since it has an intrinsic value, which the others lack. If both the expiry date and the underlying asset remain constant, the premium will be higher.
How is an ITM option priced in India?
The price of an ITM option in India consists of the intrinsic value plus the time value/premium. Intrinsic value is the difference between the strike price and the underlying asset’s market price.
Do ITM call options have more intrinsic value?
Yes, deep in the money, call options have higher intrinsic value as there is a bigger difference between the strike price and the market price of the underlying.
What happens to the money options at expiry?
At expiry, the money option’s price will equal its intrinsic value, as there is no time value left. The option holder can exercise the option to buy/sell the underlying at the strike price.
