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Options trading offers traders the right to buy or sell underlying securities at a predetermined price before expiry. It paves the way for diverse strategies aimed at capitalising on market movements. There are two types of contracts call options and put options.
A call option empowers the contract holder to purchase the underlying security at a set price. Whereas, a put option allows the holder to sell at a specified price. For option trading, understanding the moneyness of options is important.
In this article, we will understand what is ITM Call Options and everything you need to know about it.
What is ITM call option?
An In-The-Money (ITM) call option occurs when the option’s strike price is lower than the current market price of the underlying security. Essentially, it lets you buy the underlying security at a lower price than what it’s currently selling for in the market.
However, successfully trading ITM call options requires a blend of experience, knowledge, patience, and timing. Holding onto the option until its expiration date without prematurely executing the trade is essential to avoid diminishing its extrinsic value.
How does ITM call options work?
Let’s understand with an example of how to buy ITM call option in stock.
Let’s say a trader buys one call option on a company called ABC. The option has a strike price of ₹2,500 and expires in one month. If ABC’s current spot (market price) is trading above ₹2,500, the call option is “in the money.”
Now, suppose ABC’s contact is trading at ₹2,800 the day before the option expires. This means the call option is in the money by ₹300 (₹2,800 – ₹2,500).
So, the trader can choose to exercise the call option and buy 100 shares of ABC for ₹2,500 each, totalling ₹250,000. Then, the trader can sell these contacts in the open market for ₹2,800 each, totalling ₹280,000.
By selling the contracts, the trader makes a profit of ₹30,000 [100 x (₹2,800 – ₹2,500)].
Despite being in the money, ITM options don’t always guarantee profits. Factors such as premiums, commissions, and brokerage fees influence the overall outcome.
To turn a profit, the market price of the contract must rise enough for the trader to cover all expenses associated with the trade, including the buying price, premium, and fees.
Due to their inherent value, ITM options are typically more expensive than other types of options. Traders pay a premium upfront to capitalise on the profit potential already embedded within the option’s contract.
Understanding these dynamics is crucial for traders navigating the complexities of options trading.
What are the advantages and disadvantages of ITM call option?
Here are some of the advantages and disadvantages you need to consider for ITM call options.
Advantages of In-the-Money (ITM) call option:
1. Profit potential:
When an ITM call option expires, the holder can profit if the market price exceeds the strike price, allowing them to buy the asset at a lower price and sell it for a higher price.
2. Delta sensitivity:
ITM call options typically have a delta closer to 1, meaning they move more in line with the underlying stock price. This provides greater leverage compared to out-of-the-money (OTM) options.
3. Flexibility:
ITM call options can be exercised by the buyer at any time before expiry to capture the intrinsic value, providing flexibility in managing trades.
Disadvantages of In-the-Money (ITM) call option:
1. Higher Cost:
ITM call options are upfrontly expensive because traders pay a higher premium for the contract, making them costlier than other options.
2. Lower Leverage:
Due to their higher premium, ITM call options offer lower leverage compared to OTM options, limiting the capital available for other trading opportunities.
3. Time Decay:
As options move deeper into ITM, time decay accelerates, reducing the option’s value faster as the expiration date approaches.
As a trader, you need to understand all these aspects before diving into the options market to reduce your overall risk. You also need to understand different moneyness in options such as the difference between OTM and ITM call options to make the most of it.
Conclusion
In-the-money (ITM) call options offer various advantages to traders. However, they also come with higher premiums. It’s essential for traders entering the options market, particularly with ITM call options, to carefully weigh these pros and cons.
By understanding the dynamics of ITM call options, traders can make informed decisions that align with their objectives and risk tolerance levels. To learn more about such financial concepts, subscribe to StockGro.
FAQs:
Deep in the money refers to an option with a strike price significantly below (for a call option) or above (for a put option) the market price of the underlying asset. These options are primarily composed of intrinsic value with minimal extrinsic or time value.
ITM stands for “In The Money.” It refers to options where the strike price is favourable to the current spot price, indicating potential profit if exercised.
Traders with a strongly bullish view of an asset’s future price may find ITM call options attractive. ITM calls allow them to profit from anticipated price increases while minimising costs compared to out-of-the-money options.
Yes, ITM call options are profitable because they have intrinsic value, which is the difference between the current stock price and the option’s strike price. This intrinsic value ensures immediate profitability and lower risk compared to At-The-Money (ATM) or Out-of-The-Money (OTM) options.
Example: ABC Company Ltd.’s contacts are currently priced at ₹750 each. If a call option has a strike price of ₹650, it is considered ITM because the option holder can buy the option and immediately sell it for ₹100 profit.