You’re undoubtedly familiar with the term ‘in the money’ (ITM) if you’re a trader. But do you know what happens to all ITM options on expiration? We’ll explore that question and discuss some of its implications for traders.
ITM options and their expiry
There are two types of ITM options: call options and put options. A call option is an agreement that gives an investor the right, but not the duty, to buy an asset at a set-out price within a specific period. A put option is an agreement that gives an investor the right, but not the duty, to sell an asset at a set-out price within a specific period. Both options will expire if they are not exercised by the expiration date.
Expiration dates are typically set at three months, six months, or one year. If an option expires ITM, then the investor will receive a payout. If an option expires OTM (‘out of the money’), the investor will lose the premium paid for the option.
How do ITMswork?
In the world of trading, ITMs (in the money options) are contracts that give the holder the right to buy or sell underlying assets at a price that is above (for call options) or below (for put options) the current market price. If a trader buys a call option on ABC stock with a strike price of $50 and is currently trading at $60, the option is in the money.
Conversely, if the same trader buys a put option on ABC stock with a strike price of $60, and the stock is currently trading at $50, the option is in the money. Because ITMs have intrinsic value, they are generally more expensive than OTM options. However, they also offer greater potential rewards if the market moves in the desired direction. ITMs are essential for traders who seek to profit from bullish and bearish market movements.
Why do they expire?
So why do most options contracts expire ITM? There are a few reasons.
First, as time passes and an options contract approaches its expiration date, it loses time value. Less time remains for the underlying asset to move into a profitable position. Second, most investors buy options with a specific goal in mind. For example, a trader who buys a call option may do so because they believe the underlying asset will increase value. If the asset doesn’t reach the desired price by expiration, the option will expire ITM.
Likewise, a trader who buys a put option may do so because they believe the underlying asset will decrease. If the asset doesn’t reach the desired price by expiration, then the option will expire ITM.
Do all ITM options get exercised on the expiry?
The answer is no, as it depends on the type of option. The buyer may choose not to exercise their option with a physical delivery option if the underlying asset has decreased since they purchased the option. With a cash delivery option, the buyer will always receive at least the underlying asset’s value, even if it has decreased in value, so there is no incentive for them not to exercise their option.
What happens if an ITM option expires unexercised?
If an ITM option expires unexercised, the owner forfeits the option’s intrinsic value. For instance, say you own a call option with a strike price of $50, and the stock price is currently $55. It means that exercising your option and buying the stock for $50 and then selling it immediately for $55 would give you a profit of $5.
However, if you choose not to exercise your option, you forfeit this potential profit; even though you forfeit the intrinsic value by not exercising an ITM option, you still have the opportunity to sell the option before expiration.
Since there is time value left in the option, you may be able to sell it for more than its intrinsic value. However, if the stock price drops below the strike price before expiration, the option will become worthless, and you will have lost both the intrinsic and time value.
For this reason, it is essential to carefully consider whether or not to exercise an ITM option before expiration.
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