SERIES 7 PREP | FINANCIAL REGULATION COURSES
In the money is the term used to describe an options contract that has intrinsic value — a call option whose underlying stock price is currently above the strike price, or a put option whose underlying stock price is currently below the strike price. An option that is in the money can be exercised immediately for a profit before accounting for the premium paid, and the degree to which it is in the money equals its intrinsic value. Understanding in the money and its relationship to at the money, out of the money, intrinsic value, and time value is among the most heavily tested concepts on the SIE and Series 7 examinations.
The Three Pricing States — ITM, ATM, OTM
Every option at every moment exists in one of three pricing states relative to the current market price of the underlying security and the option's strike price. These states — in the money, at the money, and out of the money — are not fixed characteristics of the option. They change continuously as the underlying security's price moves throughout each trading day.
In the money means the option has intrinsic value — exercising it immediately produces an economic benefit. At the money means the underlying security's current market price equals the strike price exactly — intrinsic value is zero, and the entire option premium consists of time value. Out of the money means the option has no intrinsic value — exercising it immediately would produce a loss relative to transacting directly in the market — and the entire premium consists of time value. Out of the money options are not exercised because doing so would be economically irrational.
In the Money Calls
A call option gives the holder the right to buy one hundred shares of the underlying security at the strike price. A call option is in the money when the current market price of the underlying security is above the strike price — the holder can exercise the right to buy at the strike price, which is below the current market price, and immediately own shares worth more than was paid for them.
The mnemonic used universally in Series 7 examination preparation is call up — calls go in the money when the market price goes up above the strike price.
If a stock is trading at sixty-two dollars and an investor holds a call option with a fifty-eight dollar strike price, the call is in the money by four dollars. The intrinsic value is four dollars per share, or four hundred dollars per contract covering one hundred shares. If the same stock were trading at fifty-four dollars, the call would be out of the money by four dollars — exercising it would mean paying fifty-eight dollars for stock trading at fifty-four dollars, which makes no sense.
In the Money Puts
A put option gives the holder the right to sell one hundred shares of the underlying security at the strike price. A put option is in the money when the current market price of the underlying security is below the strike price — the holder can exercise the right to sell at the strike price, which is above the current market price, and receive more than the shares are worth in the market.
The mnemonic is put down — puts go in the money when the market price goes down below the strike price.
If a stock is trading at forty-four dollars and an investor holds a put option with a fifty dollar strike price, the put is in the money by six dollars. The intrinsic value is six dollars per share, or six hundred dollars per contract. If the same stock were trading at fifty-three dollars, the put would be out of the money by three dollars — exercising it would mean selling shares at fifty dollars when the market pays fifty-three dollars, which no rational holder would do.
Intrinsic Value — The Precise Calculation
Intrinsic value is the dollar amount by which an option is in the money. It is always zero or positive — a negative intrinsic value is simply zero, because no rational investor exercises an out of the money option.
For calls: intrinsic value equals the current market price of the underlying security minus the strike price, but not less than zero.
For puts: intrinsic value equals the strike price minus the current market price of the underlying security, but not less than zero.
Worked examples confirm this. A seventy call when the stock trades at seventy-six has intrinsic value of six dollars — seventy-six minus seventy. A seventy call when the stock trades at sixty-five has intrinsic value of zero — the call is out of the money. A seventy put when the stock trades at sixty-three has intrinsic value of seven dollars — seventy minus sixty-three. A seventy put when the stock trades at seventy-eight has intrinsic value of zero — the put is out of the money.
Option Premium — Intrinsic Value Plus Time Value
The total option premium — the price paid to acquire the option — equals intrinsic value plus time value. This relationship is fundamental and is tested constantly on the Series 7 examination.
Time value, also called extrinsic value, represents the additional amount investors pay above the intrinsic value for the possibility that the option will move further in the money before expiration. It is driven by time remaining to expiration, implied volatility of the underlying security, and the relationship between the current price and the strike price. All else equal, time value declines as expiration approaches, reaching zero at expiration itself — a process called time decay or theta.
An in the money call with a strike of seventy, underlying stock trading at seventy-six, and a total premium of eight dollars has intrinsic value of six dollars and time value of two dollars. An out of the money call with a strike of eighty, same stock trading at seventy-six, and a premium of three dollars has intrinsic value of zero and time value of three dollars — the entire premium is time value.
At expiration, time value is zero for every option. At expiration, an in the money option is worth exactly its intrinsic value. At expiration, an out of the money option is worth zero and expires worthless.
The OCC Exercise-by-Exception Rule
The Options Clearing Corporation — the central counterparty and guarantor for all standardised exchange-listed options in the United States — applies the exercise-by-exception procedure at expiration for all equity options. Under this procedure, any option that is in the money by one cent or more per share at expiration is automatically exercised on the option holder's behalf unless the holder provides specific contrary instructions to their broker-dealer before the applicable cutoff time.
FINRA Rule 2360 establishes that the cutoff for customer instructions regarding exercise at expiration is five-thirty PM Eastern Time on the expiration day. The OCC itself processes expiration settlement based on closing prices. The exercise-by-exception rule ensures that in the money options are not inadvertently abandoned by investors who fail to submit exercise instructions — the OCC exercises them automatically. Option holders who do not wish to exercise an in the money option at expiration must affirmatively instruct their broker not to exercise before the cutoff.
ITM, ATM, OTM and Option Premium Levels
Option premiums reflect the pricing state of the option. In the money options carry higher premiums than at the money or out of the money options with the same expiration date, all else equal, because they already contain intrinsic value in addition to any time value. An in the money option trading at eight dollars when the intrinsic value is six dollars carries two dollars of time value. An at the money option with zero intrinsic value might carry three dollars of time value — reflecting the symmetric probability that the stock moves in the favourable direction before expiration. An out of the money option might carry one dollar of time value — a lower probability that the market moves enough to bring the option into the money before expiration.
For buyers, in the money options cost more but provide immediate intrinsic value and lower percentage risk of total loss. For sellers, selling in the money options generates more premium income but creates more immediate obligation risk because the option is already exercisable for a profit.
Examination Drill — Four Scenarios
The Series 7 examination tests in the money identification through precise scenario analysis. Candidates must work quickly and accurately through calls and puts with different strike prices and market prices.
ABC trades at sixty-two. Which of the following are in the money? An ABC sixty call — in the money by two, call is above strike. An ABC sixty-five call — out of the money, market below strike. An ABC sixty put — at the money, zero intrinsic value. An ABC sixty-five put — in the money by three, put is below strike.
DEF trades at forty-eight. Which are in the money? A DEF forty-five call — in the money by three. A DEF fifty call — out of the money. A DEF forty-five put — out of the money. A DEF fifty put — in the money by two.
Working through scenarios like these rapidly and accurately is the core examination skill. The mnemonic — call up, put down — applied consistently produces correct answers without requiring rederivation of the underlying logic each time.
Examination Relevance and Key Takeaways
In the money is tested on the SIE, Series 7, and Series 65 examinations in the context of options terminology, intrinsic value calculations, option premium decomposition, and the OCC exercise-by-exception rule.
The key points to retain are these.
A call option is in the money when the underlying stock price is above the strike price — call up. A put option is in the money when the underlying stock price is below the strike price — put down. At the money means the stock price equals the strike price exactly. Out of the money means the option has no intrinsic value and would be irrational to exercise. Intrinsic value equals the in the money amount — for calls, market price minus strike price; for puts, strike price minus market price — never negative. Option premium equals intrinsic value plus time value — at expiration time value is zero and in the money options are worth their intrinsic value while out of the money options expire worthless. The OCC exercise-by-exception rule automatically exercises any equity option in the money by one cent or more at expiration unless the holder provides contrary instructions to their broker-dealer by five-thirty PM Eastern Time on the expiration day under FINRA Rule 2360.
