Deep in the money is an option with a strike price (or exercise price) considerably lower or higher than the market price of the asset. A deep-in-the-money call option is selling significantly lower than its market price. While a deep-in-the-money put option is selling for a significantly higher price than its market price.
A deep-in-the-money option’s value is mostly intrinsic value and some extrinsic or time value. Meaning that the value of the deep-in-the-money option highly depends on the change in its market price.
Most deep-in-the-money options have a delta close to 1 or 100% which means that the price of the option will expectedly increase or decrease with the change in the market price of the asset or security.
Deep-in-the-money options have a strike price of at least $10 higher or lower than the price of the asset. If the option is for low-priced equity, the strike price must be at least $5 higher or lower (depending on whether it is a call or put option) than the price of the asset.
Who Should Buy Deep-in-the-Money Options?
Deep-in-the-money options are best for long-term investors who want huge returns and are also ready to take considerable amounts of risk. An investor who invests in assets or securities can also invest in options to benefit from low capital outlay, leverage, a limited risk, and a higher potential of profit.
Although deep-in-the-money options have limited risk, they have a considerable amount of risk. The holder of a deep money option benefits in the same way as the holder of stock. But these options can be profitable only if the price of the option moves in the desired direction. The price must move higher for call options and move lower for put options.
Because there is a probability that the stock’s price can move in the opposite (undesirable) direction, it results in a loss of value. Once the intrinsic value of the option is lost, the premium remains. In such a situation, traders or investors choose not to exercise their option.
American vs European Deep in the Money Options
American options can be exercised within the period of the option. For instance, if a deep money option is for 90 days and the investor wants to exercise the option on the 88th day, the investor can go forward with exercising their option.
European options can only be exercised upon expiring. Meaning that an option with a 90-day period can only be exercised after the 90th day.
American deep money options can be exercised early, allowing the investors to benefit from the higher price at any point in time before it expires.
Deep in the Money Example
Let’s say that an investor wishes to purchase deep the money call option of stock X. Stock X is trading on August 21 at a market price of $300. The November call options for stock X have strike price of $150, $200, $225, $250, $300, and $350.
The strike price of $150 is the deep-in-money option because it is 4 strike prices lower than the $300 (the current market price).