options

In the Money vs Out of the Money Options

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You may have heard options sometimes referred to as being "in the money" or "out of the money". If you're not familiar with those terms, then you're in the right place to learn more about them.

For any given set of options, there are often a number of different strike prices available. In the money and out of the money options refer to distinct sets of strike prices from any series of options. They each have unique characteristics that are helpful to be aware of if you're considering investing in options.

 

Meaning of In the Money vs Out of the Money Options

Let's start with in the money options. The formal definition of in the money options is as follows:

For call options, those are options where the strike price is lower than the stock price.

For put options, those are options where the strike price is higher than the stock price.

Now let's compare that to out of the money options. The formal definition of out of the money options is as follows:

For call options, those are options where the strike price is higher than the stock price.

For put options, those are options where the strike price is lower than the stock price.

This video about in the money options vs out of the money options might help improve your understanding:

 

 

Example of In the Money vs Out of the Money Options

Now that you know the book definition of each term, let's look at an example to make it easier to connect the dots on how in the money differs from out of the money.

Imagine that you're considering the idea of buying Amazon options, and imagine that Amazon stock is selling for $105.

Now imagine that you're evaluating three call options, as shown in the image below:

 

 

Since these are call options, we know that any options where the stock price is lower than the strike price will be out of the money, and any options where the stock price is higher than the strike price will be in the money.

In the example above, the option in green text is the only option where the stock price is lower than the strike price. The stock price of $105 is lower than the strike price of $110. It is therefore out of the money.

The option in blue text is the only option where the stock price is higher than the strike price. The stock price of $105 is higher than the strike price of $100. It is therefore in the money.

Notice that the option in black test is neither in the money nor out of the money. The strike price is equal to the stock price, which means it is therefore at the money.

It doesn't matter what expiration date these options have since that doesn't affect whether any given option is out of the money.

 

Cost of In the Money vs Out of the Money Options

Option prices are made up of two components: intrinsic value and extrinsic value.

Intrinsic value represents how far in the money the option is. The further in the money it is, the higher the intrinsic value, and typically the higher the price of the option.

Since out of the money options have no intrinsic value, it means their price is made up entirely of extrinsic value.

Extrinsic value is typically highest in the strike prices that are closest to the stock's price. Therefore the the further in the money or out of the money the option is, the lower the extrinsic value typically is.

 

Learning More About In the Money vs Out of the Money Options

If you need more help getting up to speed on the difference between in the money vs out of the money options or on options in general, take a look at our guide to options trading for beginners.

If you'd rather leave it to the pros but still want good option investment ideas, you can consider signing up for our options alert service.

You can contact us any time if you would like to ask any questions about extrinsic value or about options in general.