There are a variety of terms used in the financial world that may be unfamiliar to those who are not actively engaged in trading. Let’s explore the concepts of ‘in the money and ‘out of the money’ concerning options trading in the United Kingdom. We’ll also provide a few examples to help illustrate these terms. By understanding these concepts, you can make more informed choices when trading options and increase your chances of success.
What is meant by being in the money or out of the money?
When discussing options contracts, the terms ‘in the money’ and ‘out of the money’ refer to the relationship between the option’s strike price and the current market price of the underlying security.
If the market price of the security is higher than the strike price of the call option, then the option is in the money.
Conversely, if the underlying security’s market price is below the put option’s strike price, then that option is in the money. If an option is not in the money, it is considered out of the money. Out of the money, options have no intrinsic value, but they may still have extrinsic or time value.
Time value is determined by how much time is left until expiration and how volatile the underlying security is. Ultimately, whether an option is in or out of the money will significantly impact its value.
How this affects investments and pensions
The effect that in the money or out of the money has on investments and pensions depends on the type of investment or pension. For example, with a stock option, being in or out of the money will affect whether or not the option is exercised.
With a futures contract, being in or out of the money will determine whether or not a profit is made. And with a pension plan, being in or out of the money can affect how much income is received during retirement.
In general, being in the money is more advantageous than being out of the money regarding investments and pensions. There are exceptions to this rule.
For example, suppose an investor holds a stock option deep in the money (meaning a significant difference between the strike price and the current market price). In that case, they may be more likely to sell the option before expiration rather than exercise it. It is because, as the expiration date approaches, the option’s time value starts to decrease. It may no longer be worth exercising the option, and it may be more advantageous to sell it.
The difference between being in and out of the money in the UK
There are a couple of essential things to understand when discussing the differences between being in and out of the money in the UK.
First, it is essential to note that the term ‘the money’ is used for the amount of money that is returnable to a person who has placed a bet. In other words, if someone were to bet one pound on a horse that ended up winning the race, they would be said to be in the money because they would receive their original stake back plus winnings.
Conversely, someone who had placed a bet on a horse that did not win would be said to be out of the money because they would only receive their original stake back and would not win any additional money.
Examples of each
An ‘in the money’ option is one where the underlying asset’s market price is higher than the option’s strike price.
For a call option, the investor would be able to buy the asset at a lower price than its current market value. For a put option, the investor would be able to sell the asset at a higher price than its current market value.
An ‘out of the money’ option is one where the underlying asset’s market price is lower than the option’s strike price.
For a call option, the investor would not be able to buy the asset at a lower price than its current market value. For a put option, the investor would not be able to sell the asset at a higher price than its current market value.
Options ‘in the money’ are more expensive than ‘out of the money’, as the former provides the investor with more potential upside than the latter.
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