Question

What does it mean to say that an option is "in the money"?

a)If its exercise produces a positive payoff to the holder.
b)If the holder would be indifferent between exercising the option or not.
c)If its exercise produces negative payoff to the holder.
d)All of these

Answer 1

The correct answer is option (a) - if an option's exercise produces a positive payoff to the holder, it is considered 'in the money'.

Step-by-step explanation:

An option is considered 'in the money' when its exercise produces a positive payoff to the holder. This means that if the holder chooses to exercise the option, they will make a profit. For example, if someone holds a call option to buy a stock at $50 and the current market price is $60, the option is 'in the money' because exercising it would allow the holder to buy the stock at a lower price and sell it in the market for a higher price, resulting in a profit.

This is different from an option being 'out of the money', which means the exercise of the option would result in a negative payoff or loss to the holder. If the market price in the previous example was $40, exercising the call option would result in a loss because the holder would be buying the stock at a higher price than the current market price.