Lesson #1: What are Options? / Lesson #2: How options are priced / Lesson #3: Calls and Puts / Lesson #4: How options increase in value / Lesson #5: Time and Options / Lesson #6: Strike Price / Lesson #7: In, At and Out of the Money / Lesson #8: Option Risks / Lesson #9: Writing Options

As mentioned in Lesson #6, the Strike Price is the pre-agreed price which the underlying stock in the option can be purchased or sold. As we discussed in that lesson, the strike price it goes up in preset intervals. For stock less than $25, the Strike Price is set at $2.50 intervals and for stocks worth over $25, the Strike Price is set at $5.00 intervals.

This means that if XYZ stock is worth $18.34, the nearest Strike Price, based on $2.50 intervals, would be either $17.50 or $20.00. If your stock is worth $33.25, the nearest strike price would be either $30.00 or $35.00, based on $5 intervals.

Since it is very rare that the underlying value of the stock will be equal to the Strike Price, this leads to a peculiar feature in options -- where you buy an option in, at or out of the money.

At the Money Option

In the rare circumstances, where the price of the stock matches one of the intervals (or is within a few cents), it is considered to be "at the money."

In the Money Option

Using our XYZ stock which is currently selling for $18.34, the nearest Strike Price would be either $17.50 or $20.00. If we decide to buy a call option and choose the Strike price of $17.50, our option is considered to be in the money. What we mean by that is that our option is already profitable. By buying this Option we have the right to buy the stock for $17.50 and can turn around and sell it for $18.34. Because of this, the Option price is higher to make up for this profitability. Though the option price is higher, it can result in a higher delta.

Out of the Money Option

Using our XYZ stock example of 18.34, if we were to buy the option with a strike price of $20,00, we are immediately in a loss position and have purchased an option considered out of the money. We have the right, but not the obligation, to buy the stock from an individual for $20 but can only sell it for $18.34. Since we are buying the option in a loss position, its value is considerably less than an "At the money" or "In the Money" option. The delta is also quite lower.

Reverse the procedure for Put Options

Note for Put Options the reverse is true. Since we are hoping that the underlying stock will go down in value, because the one selling the option to us has agreed buy the underlying stock from us at the agreed Strike Price. I.e. he has agreed to buy the stock from us for $20.00, in the meantime, we hope that the price will drop in price so we can buy it at the lower price and then turn around and sell it to him for the higher price. In this instance, an "in the money option" would refer to an option where the value of the stock is lower than the Strike Price., XYZ is trading at 20.00 we would by a put option at 22.50 this would be an in the money option, out of the money would be a strike price of 17.50 at the money would be a strike price of 20.00.