A stock option that is considered to be in the money holds what is called intrinsic value. The intrinsic value of an option is the difference between the strike price and the actually share price of the stock. In this case, the strike price of the option is more valuable than the actual share price of the stock if it were to be exercised.
Both a call and a put can be considered in the money. However, the method for determining if either type of option is in the money is different.
In the Money Calls
A call option that is in the money has a strike price that is lower than the current price of the underlying stock. The owner of this type of option would have the right to exercise the contract and purchase shares of the stock for less than the current share price.
For example, a stock trading at $20 may have a call option with a strike price of $15. The owner of the option would have the right to exercise the option and purchase shares of the stock for $15, even though the current price is much higher. The investor would then be free to sell the stock for the current share price ($20) for a $5 profit or hold it for a longer period of time.
In the Money Puts
An in the money put option has a strike price that is above the current price of the stock. In this case, the owner of the option would have the right to sell shares of the underlying security for more than the current traded share price.
A stock trading at $35 per share that has a put option of $40 would be considered in the money. The owner of the put option could sell back the shares of the stock for a $5 profit per share in this scenario.
Deep In the Money Options
At times, both put and call options can fluctuate between being considered in the money or out of the money depending on where the stock is trading. This is why many option investors search out contracts that are considered to be deep in the money. A deep in the money option is generally considered to be at least one strike price above or below the current share price.
Both put and call options that are deep in the money tend to carry less risk and are valued much higher than contracts with a strike price at or near the share price.
Even though an option may be considered in the money does not mean an investor will profit from holding the contract. The buyer of the option must still pay a premium to own the right to buy or sell stock in the underlying security. If the investor ends up paying a high premium for this right, then the difference between the strike price and share price may not be enough to break even on the trade.
Regardless of how much an investor may have paid in premium for an option, one that is considered to be in the money will always hold more value than one at or out of the money.