
What is in The Money?
In the money is a term that describes the strike price of an option that is closest to where the market is currently trading. There are three “places” the strike price of an option can be.
 In The Money
 At The Money
 Out of The Money
Below is an example of three different strike prices on a Call option on the Swiss Franc. All of them will expire in 32 days which is called the Expiration Date of the option.
We are going to look at all three of these and I will explain what they mean. It’s pretty easy. Each of these options were purchased today with 32 days left until expiration.
In The Money: Notice on the chart above that the 97.00 call is labeled as “In The Money” because it has intrinsic or real money value because it’s below the current price of where the market is trading. So you the option expired today it would be profitable because when someone bought that call it gave them the right to be long from 97.00 and since the market is trading above 97.00 the Call option has “real money’ value.
The market is currently trading at 98.25 which is 1.25 dollars above the strike price. In the Swiss Franc each $1.00 move is worth $1,000.00. So this Call option has intrinsic value of $1,250.00. But notice that the cost of that Call is $2,275.00. Anything above the intrinsic value of $1,250.00 is what they call time value in this case it’s the difference between $2,275.00 (current value) and $1,250.00 of intrinsic value. But what exactly is time value? Well, time value is what is considered part of the risk value of this option because it still has 32 days left before it expires. During that 32 days the price could go up and have even more intrinsic value.
Let’s figure out what the option could be if the price jumped up to 100.00 in the next couple of days. This is not going to be exact because each day of an options life has “time value” and its time value decays. Think of an option as a block of ice. You put the block of ice outside and every day that passes the ice melts a little. Think of that ice melting as time decay.
But like I said if the price jumps up to 100.00 in the next few days, not taking into consideration any time value decay, what would the option be worth? Well the 97.00 strike price would have 3.00 in intrinsic value and each 1.00 is worth $1,000.00. So it would be worth $3,000.00. if it goes to 101.00 then it’s worth $4,000.00 and so on and so on. But if it was at 100.00 in 32 days when it expired it would expire in the money.
But how much would you make on this option? So at expiration it’s wort $3,000 you had to pay $2,275 for it so you made the difference or $725.00 less any fees and commissions.
Now before you get all bend out of whack thinking that price shot up 3.00 or $3,000 and I only made $725.00 I want you to look at it as a percent return of your investment. You invested $2,275.00 and made $725.00 which is a 31.8% return on your money. And you did that in 32 days. Heck, that 1% a day return!
At The Money: An at the money option simple means that the strike price is the closest one to where the market is trading and this case it would be a 98.50 Call. The market is currently trading at 98.25 so this at the money option has zero intrinsic value. So why is it selling for $1,187.50? You guessed it, it’s all time value. The seller of that option wants the $1,17.50 for taking the risk that the option will be worth less than what he or she sold it to you for. Pretty simple but we have some math to do first.
If the market closes at 100.00 at expiration, then how much would the option be worth? Think about it. The 98.50 option would only be 1.50 in the money or $1,500.00. But did you make $1,500.00? No because you paid $1,187.50 for it so you have to subtract that from the $1,500.00. You made $312.50 on the at the money option. Now figure out what percentage that is.
Out of The Money: The 100.00 Call is out of the money because when you bought it, it had no intrinsic value either. But it only cost $537.50. Why was it so cheap? It’s because the seller of the option took much less risk on it. If the market is at 1.00 at expiration, then the option would expire worthless and you would lose the $537.50 you paid for it.
Now if each 1.00 move makes or loses $1,000.00 where would price have to be for you to make any money at expiration? It would have to be at least 1 tick/point above 100.00 + what you paid for it. Let’s call it .54 points which is $540.00. So anything above 1.54 at expiration is a profit for you.
An important thing to remember in trading options that that when you BUY and option the maximum amount you can lose is the amount you paid for the option. You can never lose more than that. There is no limit on how much you can make though.
Here is a little homework assignment for you. On EACH of the three options above if you were the seller of the option where would the price have to close at or below for you to lose money. Remember on the Swiss Franc each 1.00 move is worth $1,000.00.
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