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Deep in the Money

Deep in the Money
TradingStrategy and EducationOptions and Derivatives TradingOptions and DerivativesOptions Trading Strategy and Education

What Is Deep in the Money?

Deep in the money is an option that has an exercise or strike price fundamentally below (for a call option) or above (for a put option) the market price of the underlying asset. The value of such an option is practically all intrinsic value and insignificant extrinsic or time value. Deep in the money options have deltas at or close to 1.00 (or 100%), and that means the price of the option is expected to increase or diminish almost as one with the change in market price of the underlying security.

Deep in the money options can be diverged from those deep out of the money, which rather have no intrinsic value and furthermore negligible extrinsic value. These options have deltas close to zero.

Seeing Deep in the Money

The Internal Revenue Service (IRS) characterizes deep in the money options as by the same token:

  • Any option with a term of less than 90 days that has a strike price that is one strike not exactly the highest accessible stock price.
  • An option with a term of over 90 days, with a price under two strikes than the highest accessible stock price.

An option is typically supposed to be "deep in the money" assuming that it is in the money (ITM) by more than $10. In this way, on the off chance that a call option is deep in the money, it means that the strike price is no less than $10 not exactly the underlying asset, or $10 higher for a put option. For lower-priced values, $5 or less might be the level important to be deep in the money.

The main characteristic of this type of option is its significant intrinsic value. To compute the value of a call option, one must deduct the strike price from the underlying asset's market price. For a put option, you would add the strike price to the underlying asset price.

Deep in the money options have an exceptionally high delta level, implying that the options will move almost in lock-step with the underlying asset.

As a call option moves deeper into the money, its delta will approach 100%. At this delta, each point change of underlying asset price brings about an equivalent, simultaneous option price change in a similar course.

Consequently, deep in the money options are a brilliant strategy for long-term investors, especially compared to at the money (ATM) and out of the money (OTM) options. Investing in the option is like investing in the underlying asset, aside from the option holder will have the benefits of lower capital outlay, limited risk, leverage, and greater profit potential.

Special Considerations

Deep in the money options permit the investor to profit something similar or almost the equivalent from a stock's movement as the holders (or short sellers) of the real stock, in spite of costing less to purchase than the underlying asset. While the deep money option conveys a lower capital outlay and risk; they are not without risk.

Since options have a limited life expectancy, in contrast to stocks, the investor (the buyer of the option) needs the underlying stock to move in the ideal course (higher for calls and lower for puts) inside the predefined period to create a gain. There is dependably the possibility that the stock will move in something contrary to the ideal course, leading the option to lose value and even possibly fall OTM. In that case, intrinsic value declines or totally vanishes, leaving just the premium, which is helpless before time decay.

Traders will frequently hope to close out deep in the money options by exercising them early, which is just considered American options — European options must be exercised when they lapse. Doing so can assist with cleaning up a merchant's options position, while likewise catching better interest rates (on account of deep puts) or dividends (on account of deep calls).

This is on the grounds that possessing a deep put is successfully equivalent to being short the stock — yet without being credited the short proceeds that can earn interest. Moreover, being long a deep call is really equivalent to being long the stock, however contract holders wouldn't receive the dividends paid except if they owned the shares all things considered.

Deep in the Money Example

Assume an investor purchases a May call option for stock ABC with a strike price of $175 on Jan 1, 2019. The closing price for ABC was $210 on Jan 1, 2019, and strike prices for May call options around the same time were: $150, $175, $210, $225, and $235.

Since the option term is over 90 days, the call option with a strike price of $150 (two strikes under $210) is a deep in the money option. Simultaneously, these options both likely have deltas some place in the high 0.90s.

Adjustment Dec. 24, 2021: This article has been altered to explain that the maximum conceivable delta value for an option is 1.00 (now and again called "delta one" or "100 delta").

Highlights

  • Traders will frequently exercise deep in the money options early (in the event that they are American style).
  • These options have almost a 100% delta, implying that their price changes in step with each change in the underlying asset's price.
  • Deep in the money options have strike prices that are fundamentally above or below the underlying's market price, and in this manner contain a for the most part intrinsic value.