In the money options refer to options that have intrinsic value. Another way to think of intrinsic value is the value of the option at expiration time or the value of the option if you were to exercise it right now. Out of the money options have no intrinsic value or would have no value if you were to exercise right now.
There are pros and cons of buying ITM vs OTM options. As you go deeper in the money, options behave more and more like the stock, where a dollar move in the stock would represent a dollar move in the option. The benefit of buying ITM options is that the option price is not going to be as affected by time decay. The disadvantage is that the options cost more as you go deeper in the money which will reduce your leverage.
The advantage of buying OTM options is that they cost less and that gives you the possibility of much greater leverage. The disadvantage of OTM options is that you need greater movements in the underlying stock the farther out of the money you go.
Determining whether to buy ITM or OTM, or how deep ITM or how far OTM, comes down to your preference and your analysis. When deciding which option to pick, use option calculators to calculate the value of the option based on where you think the stock’s price is going to be. You can than determine which option would give you the best percentage return based on your analysis. Also consider what the option would be worth if the stock goes against you. Decide the stock price that would indicate your trade isn’t going to work out. Again use the option calculator to determine the value of your option at that stock price. Determine if the loss is acceptable to you.
Ultimately ITM or OTM is neither right nor wrong. It will be based on your analysis and your preferences.
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