In the Money vs. Out of the Money contracts
In options trading "In the Money" vs. "Out of the Money" are commonly used terms that refer to the position of the strike price in relation to the share price of the underlying asset. This relationship is known as the "Moneyness" of the options contract.
In the Money (ITM)
An "In the Money" contract refers to an options contract where the strike price is greater than the current share price of the underlying asset.
Calls: For calls, an "In the Money" contract refers to a contract where the strike price is lower than that of the current share price of the underlying asset. For example, a contract that has a strike price of $50 would be "In the Money" if the share price of the underlying asset was $55 since the strike price of the contract is less than the share price of the underlying.
Puts: For puts, an "In the Money" contract refers to a contract where the strike price is greater than that of the current share price of the underlying asset. For example, a contract that has a strike price of $100 would be "In the Money" if the share price of the underlying asset was $97 since the strike price of the contract is greater than the share price of the underlying.
Out of the Money (OTM)
An "Out of the Money" contract refers to an options contract where the strike price is not yet greater than the current share price of the underlying asset.
Calls: For calls, an "Out of the Money" contract refers to a contract where the strike price is greater than that of the current share price of the underlying asset. For example, a contract that has a strike price of $25 would be "Out of the Money" if the share price of the underlying asset was $23 since the strike price of the contract is greater than the share price of the underlying.
Puts: For puts, an "Out of the Money" contract refers to a contract where the strike price is lower than that of the current share price of the underlying asset. For example, a contract that has a strike price of $75 would be "Out of the Money" if the share price of the underlying asset was $77 since the strike price of the contract is less than the share price of the underlying.
Differences between ITM vs. OTM contracts
"Out of the Money" contracts are less expensive than "In the Money" contracts because OTM contracts hold no intrinsic value, therefore, expiring worthless. OTM contracts typically have a larger margin for profit than ITM contracts because a change in the share price of the underlying stock has more of an impact on the price of an OTM contract. ITM contracts have intrinsic value as well as time value. Since ITM contracts have intrinsic value the profitability is usually smaller than that of OTM contracts. This does not mean that ITM contracts do not have large price moves.
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