What is an in the money stock option?

An in the money stock option is an option (ITM) that is below the strike price of the option for a call and above the strike price of an option for a put option. It is simply were you would be in cash. Confused?

For example let us say stock XYZ in trading at $45. You buy the $40 call option. This gives you the right to buy the stock at $40. Or $5 below what this stock is trading at. This is called an ITM option. You are already in cash. Of course you probably had to pay about $7 for this right. As the stock goes up and in the money option will go up at a faster rate than the stock.

There is another type of option called an out of the money option. If we bought a $50 call for $.50 this would be an example of an OTM.

There are advantages and disadvantages to buying an in the money stock option as opposed to an out of the money option. When you buy an ITM option the stock does not have to do much. If the stock went up from $45 to $49 the $40 call that you bought for $7 would not be worth at least $9. Because $49-$40=$9. This is a 28.57%percentage increase in the option VS a 8.88% percentage increase that the stock made.

On the other hand the $50 call would be worth $0. You would lose your entire premium of $.50. This is because the stock is below $50.

The disadvantage to buying the ITM option is that you will make less of a return if the stock makes a massive jump. For instance, if XYZ went from $45 to $52 your $40 call option would be worth at least $12. This gives you a 71.43% percentage increase. This still gives you a higher rate than buying the stock would. But not as much as the OTM option would.

The $50 call option would be worth at least $3 ($53-$50=$3). This would give you a 500% percentage return. This is a much higher rate of return. With much higher risk.

Some traders like the lower risk lower reward you get when you buy in cash. Others like the higher risk higher reward option. Every trader has to decide which one works best for them.

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