When Is a Put Option Considered to Be “In the Money”?

A put option is the opposite of a call option. The holder has the right but not the obligation to buy an underlying security at a specified strike price before it reaches its expiration date in the case of a call option. A put option gives the holder the right but not the obligation to sell a certain amount of the underlying asset or security by the expiration date at a certain price. A put that’s in the money has intrinsic value.

Investing can be a very rewarding experience but it can be a little daunting, not to mention intimidating, with all the options out there. Most investors start with stocks, bonds, and mutual funds because they’re the simplest and most common vehicles from which to choose. Other investments require a little more experience and research to generate a profit. Options trading is one of them.

Key Takeaways

• Investors with put options have the right but not the obligation to sell shares in an underlying security at a certain price by a specified date.
• A put option is said to be in the money when the strike price is higher than the underlying security’s market price.
• Investors commonly use put options as downside protection which cuts or prevents a drop in value.
• Puts may give investors short market exposure with limited risk if the underlying asset’s price rises.
• A put option’s time value can also affect the option’s value.

Put Options: An Overview

An options contract is a financial derivative that represents a holder who buys a contract sold by a writer. Options can be both calls and puts. Both can be used to trade any number of underlying assets or securities including stocks, bonds, commodities, currencies, indexes, and futures.

This price is referred to as the strike price. Both call and put options can be either out of the money (OTM), at the money, or in the money (ITM). This moneyness of options describes a situation that relates the strike price of a derivative to the price of its underlying security whether they’re calls or puts.

A put option that’s in the money is one whose strike price is greater than the market price of the underlying asset. The put holder has the right to sell the underlying asset at a price that’s greater than where it currently trades. It allows for an immediate profit if the contract holder buys the shares back at the market price when an option is in the money. The price of an ITM put therefore closely tracks changes in the underlying asset or security.

Note

In the money options always have deltas greater than 0.50.

How Put Options Work

A put option buyer has the right but not the obligation to sell a specified quantity of the underlying security at a predetermined strike price on or before its expiration date. The seller or writer of a put option is obligated to buy the underlying security at a predetermined strike price if the corresponding put option is exercised.

Put options are used as downside protection. They’re strategies used to mitigate if not completely prevent a drop in its value. Owning the underlying asset with the right to sell it at some price effectively gives you a guaranteed floor price. Put options can also be used to speculate on an underlying asset if you think it will go down in price. A put can therefore give short market exposure with limited risk if the underlying security does rise.

Important

A put option should only be exercised if the underlying security is in the money.

When Is a Put Option “In the Money?”

A put option is considered in the money (ITM) when the underlying security’s current market price is below that of the put option. It’s said to be in the money because the put option holder has the right to sell the underlying security above its current market price. The right to sell has a value equal to at least the amount of the sale price less the current market price when there’s a right to sell the underlying security at a price higher than its strike price.

An ITM put option is therefore one where the strike price is above the current market price. It means that the stock price is below the strike price when an investor holds an ITM put option at expiry. The option may be worth exercising. The buyer of a put option wants the stock’s price to fall far enough below the option’s strike to at least cover the cost of the premium for buying the put.

The amount that a put option’s strike price is greater than the current underlying security’s price is known as intrinsic value because the put option is worth at least that amount.

Special Considerations

Put options allow the contract holder to lock in a price to sell the underlying asset by a predetermined time. An option is settled when it expires. It may expire worthless or with some value left. The underlying asset’s price can make the value of a put and a call option fluctuate along with another factor known as its time value.

The time value is an additional premium that investors are willing to pay above the option’s intrinsic value. The basic formula to figure out an option’s time value is to subtract its intrinsic value from the premium:

$Time Value = Option Premium – Option’s Intrinsic Value$TimeValue=OptionPremium−Option′sIntrinsicValue

Investors are often willing to pay this premium because they believe the value of the option will increase before it expires. An option’s time value is greater when there’s a greater length of time until it expires. The option’s intrinsic value increases when it gets deeper in the money. Investors can use this formula to determine how much they’re willing to spend for an option. You’d want to ensure that the premium is higher than the option’s intrinsic value or you’d end up losing on the purchase.

Note

The intrinsic value of any financial instrument is the measure of its worth using objective calculations instead of the current market price. ITM options have some intrinsic value by definition.

Use This in Real Life

Assume that you have a put option for shares in Company XYZ. This contract gives you the right to sell 100 shares of the company at a strike price of $100. You purchased the put option at a premium of $10 because you believed the stock price would drop before the expiration date.

Your hunch proves to be correct and the stock price dips to $75 per share at the expiration date. The put option is in the money.

You could exercise the option and net yourself a profit of $15 per share: the difference between the strike price and the actual price of the stock and the premium you paid or $25 – $10. You get a profit of $1,500 if you multiply that by the number of shares: 100.

What Happens If My Put Option Expires in the Money?

Options can be either out of the money, at the money, or in the money. The contract holder’s stake in the underlying security is sold at the strike price when a put option expires in the money provided that the investor owns shares. A short position is initiated at the strike price otherwise. This allows the investor to purchase the asset at a lower price.

What Happens If I Sell a Put Option “In the Money”?

You can choose to exercise it when a put option is in the money. You can sell the shares of the underlying asset as outlined in the contract at the strike price and make a profit. This is generated by subtracting the current price of the asset from the strike price and then subtracting the premium you paid. You may choose to sell the contract to another buyer if you choose not to exercise it.

Is It Better to Buy ITM or OTM Options?

ITM options have both extrinsic time value and intrinsic value, making them more expensive in terms of premium. These options also have higher deltas. Traders will sometimes prefer OTM options for purposes of hedging and speculation because they have lower premiums and smaller deltas.

The Bottom Line

Investing in options can seem very intimidating at first whether you choose to invest in calls or puts. You have to wade through many fine nuances before you can fully understand how they work. But you may be able to generate big returns and increase your bottom line when you get a fundamental understanding.

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