Course: Investment Planning
Lesson 3: Equity Securities
In reviewing the tax implications of derivatives, I had a question about the terms in & out of money.
Is premium price factored into whether something is in or out of money? Or is it strictly referring to market and strike price?
Great question Lafe. And one of the CFP Board’s favorite tricks.
If I have positive cash flow at exercise, I’m in the money. If my positive cash flow is greater than the premium I paid, I’ve made a profit.
Jane Deaux paid $2/share for a 90-day $40 call option contract on KO when KO was trading at $39/share.
- The option is out of the money if she exercised immediately. She’d have negative cash flow of $1/share.
60 days later, KO was trading at $45/share.
Jane exercises her $40 call.
- She is in the money $5/share.
- She paid $40/share for a security trading at $45/share.
- She also has a profit of $3/share.
- She paid $2 premium for a stock that is in the money $5/share.
“Profit” and “in the money” are not synonyms.
Let me know if you have any other questions here.