What is In The Money/Out Of The Money?
The meaning of an "An in the money" option is an option that has intrinsic value, meaning that it can be exercised for a profit—the strike price (or exercise price) of the option is lower than the current market value of the asset. On the other hand, an out of the money option does not have any intrinsic value, since exercising it would result in a loss on its purchase. They are generally cheaper to buy than their in-the-money counterparts because they have less probability of ending up profitable. Investors often use these options as speculative investments or hedging instruments depending on their risk appetite and investment goals. The investor should take into account both the time remaining until expiration, as well as the volatility of the underlying asset, when deciding which type of option to purchase.
It is important to note that in the money and out of the money refer to the intrinsic value of an option, not its cost. The price of an option is determined by a number of factors such as time remaining until expiration, current market prices for both the asset and any other underlying assets and implied volatilities. Investors should be aware that even if an option is out of the money at present, it may become in the money before expiry depending on how market conditions have changed since it was purchased. Conversely, an in-the-money option may end up becoming worthless before expiry if market conditions deteriorate. Thus, it is important to understand the underlying asset and its volatility when deciding which options to purchase.
In conclusion, in the money and out of the money are terms used to refer to options contracts that have intrinsic value or no intrinsic value respectively. Investors who wish to use these instruments need to take into account several factors such as time remaining until expiration and implied volatilities when deciding which type of option will best suit their investment objectives. By understanding how these concepts work, investors can make better informed decisions when constructing a portfolio with these products.
Simplified Example
"In the money" and "out of the money" have to do with making money by buying and selling things. Imagine you have a toy store, and you buy a toy for $5 and you sell it for $10. You made a profit of $5, so that means you are "in the money." But if you bought the toy for $5 and then you tried to sell it for $4, you would have lost $1, and that means you would be "out of the money."
In trading and investing, "in the money" means that an option (a financial contract) has value and the holder of that option can exercise it to make a profit. "Out of the money" means the option has no intrinsic value, and the holder would lose money if they exercised it.
History of the Term "In the money/Out of the money"
The precise origins of the terms "in the money" and "out of the money" are uncertain, but they likely stem from the Latin word "moneta", meaning "money". The earliest documented use of "in the money" in English dates back to the 17th century when Thomas Hobbes employed the term in his 1642 book "Leviathan" to depict a scenario in which an individual possessed more money than necessary. On the other hand, the first recorded use of "out of the money" in English can be traced to the 18th century, with Samuel Johnson employing it in his 1743 work "A Dictionary of the English Language" to characterize someone in debt. Over time, these terms have become standardized in the financial industry, particularly in the realm of options trading, and have found application in various contexts, including gambling, to denote situations of either winning or losing.
Examples
Call Options: In the money call options are options that have intrinsic value, meaning the underlying asset price is above the strike price. For example, if a stock is trading at $100 and a call option with a strike price of $90 is in the money, the option has intrinsic value of $10. Out of the money call options are options where the underlying asset price is below the strike price and have no intrinsic value. For example, if a stock is trading at $80 and a call option with a strike price of $90 is out of the money, the option has no intrinsic value.
Put Options: In the money put options are options that have intrinsic value, meaning the underlying asset price is below the strike price. For example, if a stock is trading at $80 and a put option with a strike price of $90 is in the money, the option has intrinsic value of $10. Out of the money put options are options where the underlying asset price is above the strike price and have no intrinsic value. For example, if a stock is trading at $100 and a put option with a strike price of $90 is out of the money, the option has no intrinsic value.
Binary Options: In the money binary options are options that result in a positive outcome for the trader, for example if the trader predicts that a stock will increase and the stock does increase, the binary option is in the money. Out of the money binary options are options that result in a negative outcome for the trader, for example if the trader predicts that a stock will increase and the stock decreases, the binary option is out of the money.