By Definition

A call option, also known as a call, is a financial instrument that provides its holder with the right to buy an underlying asset at the strike price or by a specified expiry date. If the price for a call option is lower than what you would pay on the open market, then you can keep that money as profit. Options trading can be a profitable activity, but it is less straightforward than regular stock trading. We discuss below some of the benefits of buying "in the money" options below.

Important Points

• A call option is in the money (ITM) when the underlying security's current market price is higher than the call option's strike price.

• A call option has intrinsic value if it's in the money.

• Generally, the less out of the money an option is, the lower its market price will be.

• Once a call option goes into the money, it is possible to buy the security in question at a discount to market price.

• The majority of options will be exercised before expiration because their extrinsic value is lost on expiry, but this is not always the case.

When is a call option in the money?

A call option is in the money (ITM) when the underlying security's current market price is higher than the strike price of the call option. The call option is in the money because, if it expires in the money, the buyer will have a right to buy the stock at that level. When a contract gives the buyer the right to buy the underlying security below current market price, that right has intrinsic value. The intrinsic value of a call option equals the difference between the current market price and the strike price.

A call option (or alternatively a put option) gives the buyer or holder the right, but not the obligation, to purchase securities of a certain type at a predetermined price on or before an agreed-upon time frame. "In the money" describes the moneyness of an option. All derivatives have a moneyness, which is the relationship between the derivative's strike price and the spot price of the underlying security. A call option is "out of the money" if the strike price is higher than the price of the underlying security.

One major factor that determines the price of an option is its ITM status. The more ITM an option is, the more expensive it will be to purchase. On the other hand, out-of-the-money options are cheaper and less expensive the more time passes. One factor that can affect the price of an option is volatility. When you buy an option, it’s possible for the price to go up or down by a lot, which also changes its value. Therefore, if you're considering buying an option, then it may be worth looking at how volatile that particular product is and how long until the expiration date.

A Simple Example (from Investopedia.com)

For instance, suppose a trader buys one call option on ABC with a strike price of $35 with an expiration date one month from today. If ABC's stock trades above $35, the call option is in the money. Suppose ABC's stock is trading at $38 the day before the call option expires. Then the call option is in the money by $3 ($38 - $35). The trader can exercise the call option and buy 100 shares of ABC for $35 and sell the shares for $38 in the open market. The trader will have a profit of $300 (100 x ($38-$35)).

Advantages of In the Money Call Options

Once an option is in the money, it's possible to buy a security at a reduced price. This is because the trader doesn't need to own any stock to profit from the option, which can be very important in volatile markets.

When a call option goes into the money, the value of the option increases for many investors. Out-Of-The-Money (OTM) call options are highly speculative because they only have extrinsic value.

Some parts of the options market can be illiquid, but other areas might not be. Retailers of thinly traded stocks and people who are in the market for far out of the money options may find it difficult to sell them at the prices implied by Black Scholes model. If the underlying asset in your option contract is worth more than the strike price by expiration, then your call has gone into the money. As an example, ATM options are often the most liquid ones because they capture the transformation of OTM options into ITM ones.

As a rule, people don't exercise their options before they go out of the money. This also means that any remaining time value is lost. The main exception is when an option is worth a lot of money and its time decay is increasing. In this case, call options are usually the better choice since they tend to be more profitable as time passes.

What Does It Mean If a Call Option Is Out of the Money?

A call option is out of the money if the price of the underlying security is below its strike price. There is no benefit to exercising an out-of-the-money option since it's cheaper to purchase the underlying security on the market. For that reason, an option is worthless if it is out-of-the-money when it expires

Why Buy a Call Option Out of the Money?

An out-of-the-money call option is a speculative play by investors that believe the underlying stock price is likely to increase before the contract expires. If this happens, the trader profits but if it does not, then they incur losses. Many investors buy call options before a company's earnings call or other major announcement. They do this, hoping for positive news about their stock that will push the price up. One famous example of this was during the GameStop short squeeze, when retail speculators correctly predicted the stock would rise.