Definition
“Deep In The Money” is a term used to describe an option with an exercise, or strike, price that is significantly different than the market price of the underlying asset. In particular, a call option is deep in the money when its strike price is significantly below the current market price of the underlying asset, while a put option is deep in the money when its strike price is significantly above the current market price. Being deep in the money increases the option’s intrinsic value indicating a high probability that it will be exercised.
Phonetic
The phonetic pronunciation of “Deep In The Money” is:Deep: /di:p/In: /ɪn/The: /ðə/Money: /ˈmʌni/
Key Takeaways
- Definition: Deep In The Money (ITM) refers to an option with an exercise price, or strike price, significantly below (for a call option) or above (for a put option) the market price of the underlying asset. This terminology is used to describe the relationship between the strike price and the asset price.
- Value: Deep ITM options have a high delta, which means their price changes significantly when the price of the underlying asset changes. As a result, they are often used by investors wanting to bet directly on the price movement of the underlying asset, while also limiting potential losses.
- Risk: While Deep ITM options can provide more predictable returns, they carry greater upfront costs compared to at-the-money (ATM) or out-of-the-money (OTM) options. This increased cost can amount to a significant part of the portfolio, therefore, it’s critical for traders to manage their risks when dealing with these options.
Importance
The term “Deep In The Money” is significant in business/finance, particularly in options trading, as it offers one of the strongest positions for an investor in the market. It refers to an options contract that has a strike price significantly below (for call options) or above (for put options) the current market price of the underlying asset. This setup provides a high probability of the contract being exercised, translating to profit. Deep in the money options also exhibit a high delta, meaning their price movements closely correlate with the underlying asset’s price changes, again, favoring advantageous results for the investor. Besides, they also offer intrinsic value and provide a level of protection against time decay, further enhancing their importance in an investor’s portfolio.
Explanation
Deep In The Money (DITM) is typically used in options trading where the strike price of an option is significantly below (for call options) or above (for put options) the current market price of the underlying asset. This strategy is typically adopted for two main purposes: leveraging and hedging. With leveraging, buyers can control a larger amount of shares in the underlying stock for less capital. As for hedging, DITM options can act as a proxy to owning actual shares of the underlying asset, thereby offering downside protection if the stock’s price declines. The term does not simply denote an option that is in the money; it refers specifically to options that are way into the money. Because they are already in the money, these options have a much higher delta – an options term that measures how much an option price moves relative to a $1 change in the price of the underlying asset. This results in a near one-for-one match, meaning an investor can ‘control’ the corresponding number of shares in the underlying for substantially less money than owning the shares outright. This reflects the primary use of Deep In The Money options: conveniently gaining access to the movement and potential profits from underlying shares while minimising the capital at risk.
Examples
“Deep In The Money” is a term in finance that refers to an option having an exercise, or strike, price significantly below (for a call option) or above (for a put option) the market price of the underlying asset. Here are a few examples: 1. Let’s say you own a call option for Company ABC’s stock which has a strike price of $20. Currently, the market price of the company’s stock is $35. In this case, your option is considered “Deep In The Money” as the market price is significantly greater than the strike price of the option contract. 2. For a put option example, let’s say an investor bought a put option for Stock XYZ with a strike price of $50. Later, due to adverse market conditions, the price of Stock XYZ drops to $20. Here, the investor’s put option is considered “Deep In The Money” because the market price is way below the put option’s strike price. 3. Company DEF has issued a call option with a strike price of $30. Due to a significant successful product launch and positive market response, the company’s stock price has skyrocketed to $60. Here, the call option holder has the right to buy the stock at the cheaper price which is $30. Thus, the person is deep in the money as they are set to make substantial profits. Remember, being “Deep In The Money” usually means that the option is almost certain to be exercised at expiration, as it has significant intrinsic value. But it also comes with a higher upfront cost for purchasing such options.
Frequently Asked Questions(FAQ)
What is Deep In The Money in finance?
Is Deep In The Money typically for calls or puts?
How does a Deep In The Money call option work?
What’s an example of a Deep In The Money put option?
What’s the potential risk and reward for Deep In the Money options?
How are Deep In The Money options different from At The Money or Out of The Money options?
Why would an investor choose to use Deep In The Money options?
Related Finance Terms
- Options Trading
- Strike Price
- Intrinsic Value
- Call Option
- Put Option
Sources for More Information
