Deep In The Money

Definition

Deep In The Money (DITM) refers to options where there is a significant gap between the strike price and the current market price of the underlying asset, resulting in substantial intrinsic value. Specifically, for call options, the market price of the underlying asset is much higher than the strike price; for put options, the market price is much lower than the strike price. DITM options typically exhibit low time value and high intrinsic value, making them less sensitive to price changes.

Origin

The history of options as financial instruments dates back to ancient Greece, but the modern options market began to develop in the 1970s. The concept of DITM options became more familiar to investors as the options market matured, especially after the establishment of the Chicago Board Options Exchange (CBOE), which popularized options trading.

Categories and Features

The main features of DITM options include:
1. High Intrinsic Value: DITM options have significant intrinsic value, far exceeding their time value.
2. Low Time Value: Due to being deep in the money, these options have low time value and are less sensitive to price fluctuations.
3. High Likelihood of Exercise: The likelihood of exercising DITM options is very high because the underlying asset price is far above (or below) the strike price.
4. Hedging Tool: DITM options are often used to hedge risks in a portfolio because their price is primarily influenced by the underlying asset's price.

Case Studies

Case 1: Suppose a stock's current market price is $50, and an investor holds a call option with a strike price of $30. Since the market price is much higher than the strike price, this option is considered DITM. The intrinsic value is $20 ($50 - $30), and the time value may be very low. The investor can choose to exercise the option, buy the stock at $30, and sell it in the market at $50, making a profit.
Case 2: Suppose an investor holds a put option with a strike price of $70, and the underlying asset's market price is $50. Since the market price is much lower than the strike price, this option is also DITM. The investor can choose to exercise the option, sell the stock at $70, and repurchase it in the market at $50, making a profit.

Common Issues

Common issues include:
1. Why is the time value of DITM options low? Because their intrinsic value is already high, market price changes have little impact.
2. Are DITM options suitable for all investors? Not necessarily, as they are expensive and suitable for those with specific hedging needs or strong views on the underlying asset.