Question

What is meant by an option that is in-the-money? Graph this for both call and put options (identify x and y axis clearly).

Answer 1

Call option is in the money, if the stock price > strike price

Consider a call option expiring in 3 months with following data

c: price of call option = 10

K: strike price = 100

S: stock price after 3 months

Pay-off call option = max(S - K,0)

Total pay-off = max(S - K,0) - c (subtracting price of call option as it was purchased at beginning)

Stock Price at T = 3 months	Call pay-off = max(S - K,0) - c
120	max(120 - 100,0) - 10 = 20 - 10 = 10
115	max(115 - 100,0) - 10 = 15 - 10 = 5
110	max(110 - 100,0) - 10 = 10 - 10 = 0
100	max(100 - 100,0) - 10 = 0 - 10 = -10
90	max(90 - 100,0) - 10 = 0 - 10 = -10
80	max(80 - 100,0) - 10 = 0 - 10 = -10

Plot the above values in excel (stock price x axis & total pay-off y axis)

Put option is in the money, if the stock price < strike price

Consider a call option expiring in 3 months with following data

p: price of put option = 10

K: strike price = 100

S: stock price after 3 months

Pay-off call option = max(K - S,0)

Total pay-off = max(S - K,0) - p (subtracting price of call option as it was purchased at beginning)

Stock Price at T = 3 months	Put pay-off = max(K - S,0) - p
120	max(100 - 120,0) - 10 = 0 - 10 = -10
115	max(100 - 115,0) - 10 = 0 - 10 = -10
110	max(100 - 110,0) - 10 = 0 - 10 = -10
100	max(100 - 100,0) - 10 = 0 - 10 = -10
90	max(100 - 90,0) - 10 = 10 - 10 = 0
80	max(100 - 80,0) - 10 = 20 - 10 = 10