What Is Deep in the Money?
Let me explain what deep in the money means for options. It's when an option has a strike price that's way below the current market price for a call, or way above for a put. This gives the option almost all intrinsic value with very little extrinsic or time value left. You'll see these options have deltas at or near 1.00, or 100%, so they move almost exactly with the underlying security's price changes.
Compare that to deep out of the money options, which have no intrinsic value and barely any extrinsic value, with deltas close to zero.
Key Takeaways
You should know that deep in the money options feature strike prices significantly above or below the underlying's market price, making their value mostly intrinsic. They come with a delta near 100%, so their price shifts match the underlying asset's changes step for step. If you're dealing with American-style options, traders often exercise these early.
Understanding Deep in the Money
The IRS has a clear definition for deep in the money options. For terms under 90 days, it's any option with a strike one level below the highest available stock price. For longer terms over 90 days, it's a price less than two strikes below the highest.
In practice, we say an option is deep in the money if it's ITM by more than $10. For a call, that means the strike is at least $10 below the asset price; for a put, $10 above. With cheaper stocks, $5 might be the threshold.
The key here is the high intrinsic value. For calls, subtract the strike from the market price; for puts, add the strike to it. These options have high delta, so they track the asset closely.
Why Use Deep in the Money Options
As the option goes deeper in the money, its delta approaches 100%. Every point the asset moves, the option moves the same way. This makes them great for long-term investors over ATM or OTM options. You're basically investing like you own the stock, but with less money down, limited risk, leverage, and more profit upside.
Special Considerations
Deep in the money options let you gain nearly the same as stock holders or short sellers, but at a lower cost. Still, they're not risk-free. Options expire, so the stock needs to move your way in time—higher for calls, lower for puts—or you could lose out.
If it goes the wrong way, the option might lose value or go OTM, leaving just the premium to decay. Traders often exercise early with American options to simplify positions and grab better interest or dividends. Owning a deep put is like shorting without the interest credit, and a deep call is like owning without dividends unless you hold shares.
Deep in the Money Example
Take this scenario: You buy a May call on stock ABC with a $175 strike on January 1, 2019. ABC closes at $210 that day, with May strikes at $150, $175, $210, $225, $235.
Since the term is over 90 days, the $150 strike—two below $210—is deep in the money. These would have deltas in the high 0.90s.
Final Notes
Remember, this isn't tax, investment, or financial advice. It's general info without considering your specific situation. Investing has risks, including losing principal.
