Last Updated on January 31, 2024 by ethinos
An “ITM” means an “In The Money” call option. It signifies that the call option’s strike price is less than the underlying asset’s present market price. That is to say, if you exercised the call option right away, you would benefit since you have the ability to buy the asset at a cheaper price than its present market value. Because of its attractive strike price, ITM options often command a greater premium than OTM or ATM options.
Also Read: OTM Call Options
Table of Content
What Is In The Money Options: Risks And Benefits
In The Money call options have distinct risks and benefits that investors need to consider when incorporating them into their investment strategies.
Benefits of In The Money Options:
Intrinsic Value: One of the most significant advantages of ITM call options is their intrinsic value. They are called “in the money” because the strike price is favourable compared to the current market price of the underlying asset. This means that if exercised, the option immediately results in a profit.
Profit Potential: ITM call options offer an opportunity for substantial profits. They allow investors to participate in the price appreciation of the underlying asset without the need to own the asset outright. As the underlying asset’s price rises, the value of the ITM call option increases.
Reduced Time Decay: In comparison to out-of-the-money (OTM) options, ITM options are less affected by time decay. This means that as the expiration date approaches, the option’s value is more stable. It doesn’t erode as quickly as OTM options, which can make them more predictable.
Also Read: Implied Volatility In Options
Risks of ITM Options:
Higher Premium: ITM call options come with a higher upfront cost in the form of a premium. This higher cost means that investors need to commit more capital initially, which can be a significant drawback.
Limited Time Horizon: Although they are less affected by time decay compared to OTM options, ITM call options still have an expiration date. If the price of the underlying asset doesn’t rise significantly within the option’s timeframe, investors may not realise the full profit potential, and the option may expire worthless.
Market Reversal: If market sentiment swings and the underlying asset’s price decreases, the intrinsic value of the option may diminish. As a result, investors may suffer losses.
Opportunity Cost: By investing in ITM call options, investors tie up funds that could have been used for other investments or opportunities. This opportunity cost should be carefully considered.
Cost of Carry: Holding ITM call options may involve costs, such as interest or financing costs if investors use margin or borrowed funds to buy the options. These costs can eat into potential profits.
When Should Investors Consider Using ITM call option?
Investors should consider purchasing In The Money (ITM) call options in specific situations that align with their investment goals and market expectations. Here are some scenarios when an investor might consider using ITM call options:
Bullish Outlook: When an investor is strongly bullish about the future price of a particular asset, an ITM call option can be an attractive choice. ITM calls allow them to profit from anticipated price increases while minimizing the cost compared to out-of-the-money options.
Long-Term Investment: ITM call options are suitable for investors with a longer investment horizon. They provide a way to participate in the long-term appreciation of an asset without the need for a substantial upfront investment.
Risk Management: Investors holding a significant amount of the underlying asset may use ITM call options as a protective measure. By purchasing ITM calls, they can limit potential losses in case the market turns bearish.
Income Generation: Some investors use ITM call options as part of an income generation strategy. They may sell (write) covered call options with a strike price that is ITM, allowing them to generate premium income while potentially selling their holdings at a higher price.
Portfolio Diversification: ITM call options can serve as a diversification tool within an investment portfolio. They can complement other assets and strategies, helping to spread risk.
Capital Efficiency: ITM calls provide a cost-effective way to control a larger position in the underlying asset, leveraging a smaller capital outlay. This can be especially beneficial for investors looking to make the most of their available funds.
Event Expectations: When an investor anticipates specific events, such as earnings reports or product launches, that could drive the asset’s price higher, they may consider ITM call options to capitalize on these expected price movements.
Also Read: Option Volatility and Pricing Strategies
Conclusion
In conclusion, ITM options are versatile financial instruments that offer various advantages to investors. They are best suited for those with a bullish outlook on an asset, seeking to benefit from price appreciation or employing risk management strategies. ITM calls can be valuable for long-term investments, generating income, or diversifying portfolios. However, it’s crucial to carefully assess the market environment, individual objectives, and risk tolerance before engaging with ITM call options. Properly used, they can provide an efficient means of participating in asset price movements, while understanding their potential costs and limitations is essential for making informed investment decisions.
