ITM Contracts have a strike price that is of greater value than the current price of the underlying stock. this value is referred to as intrinsic value. When someone exercises an ITM call option contract, they have the right to purchase the underlying shares at the price of the strike on the contract.
Let’s say you own an AAPL call option contract with a strike price of $200 and the price of AAPL is $210. This ITM contract has $10 of intrinsic value because each share within the contract can be purchased for $10 less than AAPL is currently worth. Exercising this $200 call option contract would cost $20,000 (100 shares x $200 per share) resulting in a resulting in a 100 share position that immediately has $1,000 profit, or $10 per share within the contract.
ITM put options work slightly different. When someone exercises an ITM put option contract, they have the right to sell the underlying shares at the price of the strike on the contract. Let’s take a look at a visual example that helps explain the difference between ITM calls & puts a little better.
Now let’s say you own an AAPL put option contract with a strike price of $200 and the price of AAPL is $190. This ITM contract has $10 of intrinsic value because each share within the contract can be sold for $10 more than AAPL is currently worth. Exercising this $200 put option contract would cost $20,000 (100 shares x $200 per share) resulting in a 100 share short position that immediately has $1,000 profit, or $10 per share within the contract.
OTM Contracts have a strike price that is of lesser value than the current price of the underlying stock. this value is referred to as extrinsic value. Extrinsic value is theoretical value, derived from how much time the option has until expiration. The longer an option contract has until it expires, the more extrinsic value it has since there is more time for it to potentially move ITM.
Because OTM contracts cost significantly less than ITM contracts due to the absence of intrinsic value, it is most common for options traders to pursue OTM contracts that’s strike price would ideally go ITM within their trade idea.
