Understanding Deep in the Money Options in Trading

What Is Deep in the Money?

Deep in the money refers to an option with a strike price significantly below (for a call option) or above (for a put option) the market price of the underlying asset. The value of such an option is nearly all intrinsic value with minimal extrinsic or time value. Deep in the money options have a nearly 100% delta, meaning that their price changes in step with every change in the underlying asset’s price. Deep in the money options are a good choice for a long-term investing strategy. Benefits include a lower capital outlay, limited risk, and the power of leverage. Deep in the money options contrast with deep out of the money options, which have no intrinsic value and minimal extrinsic value. These options have deltas close to zero.

In-Depth Look at Deep in the Money Options

The Internal Revenue Service (IRS) defines deep in the money options as either:

• Any option with a term of fewer than 90 days that has a strike price that is one strike less than the highest available stock price.
• An option with a term of more than 90 days, with a price less than two strikes than the highest available stock price.

An option is deep in the money if it’s in the money by more than $10. So, if a call option is deep in the money, it means that the strike price is at least $10 less than the underlying asset, or $10 higher for a put option. For lower-priced equities, $5 or less may be the level necessary to be deep in the money. 

The key feature of deep in the money options is their significant intrinsic value. To calculate the value of a call option, one must subtract the strike price from the underlying asset’s market price. For a put option, you would add the strike price to the underlying asset price. 

As a call option becomes deeper in the money, its delta nears 100%. At this delta, every point change of underlying asset price results in an equal, simultaneous option price change in the same direction.

For this reason, deep in the money options are an excellent strategy for long-term investors, especially compared to at the money (ATM) and out of the money (OTM) options. Investing in the option is similar to investing in the underlying asset, except the option holder will have the benefits of lower capital outlay, limited risk, leverage, and greater profit potential.

Key Factors to Consider with Deep in the Money Options

Deep in the money options allow the investor to profit the same or nearly the same from a stock’s movement as the holders (or short sellers) of the actual stock, despite costing less to purchase than the underlying asset. While the deep money option carries a lower capital outlay and risk; they are not without risk. 

Because options have a limited lifespan, unlike stocks, the investor (the buyer of the option) needs the underlying stock to move in the desired direction (higher for calls and lower for puts) within the specified period to make a profit. There is always the possibility that the stock will move in the opposite of the desired direction, leading the option to lose value and even potentially fall OTM. In that case, intrinsic value declines or completely disappears, leaving only the premium, which is at the mercy of time decay.

Traders often exercise deep in the money options early, if they are American style (European options can only be exercised when they expire). Doing so can help clean up a trader’s options position, while also capturing more favorable interest rates (in the case of deep puts) or dividends (in the case of deep calls).

Owning a deep put is like being short the stock, but without earning interest on short proceeds. Likewise, being long a deep call is effectively the same as being long the stock, but contract holders would not receive the dividends paid unless they owned the shares instead.

Practical Example of Deep in the Money Options

Suppose an investor buys a May call option for stock ABC with a strike price of $175 on Jan 1, 2019. The closing price for ABC was $210 on Jan 1, 2019, and strike prices for May call options on the same day were: $150, $175, $210, $225, and $235.

Because the option term is more than 90 days, the call option with a strike price of $150 (two strikes less than $210) is a deep in the money option. At the same time, these options both probably have deltas somewhere in the high 0.90s.

The Bottom Line

Deep in the money options have strike prices significantly far from the current market price of their underlying stocks, which means that they have high intrinsic value. Their near-perfect delta indicates that their price closely follows that of the underlying asset. Their advantages include a lower initial investment compared to buying the stock, leverage opportunities, and profit potential for long-term investors. Bear in mind, though, that the limited lifespan of options necessitates timely and favorable asset price movements to ensure profitability. And, like all investment strategies, deep in the money options involve risks, including potential losses when the underlying asset price moves unfavorably.

Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.

Correction–Dec. 24, 2021: This article has been edited to clarify that the maximum possible delta value for an option is 1.00 (sometimes called “delta one” or “100 delta”).