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What is Close to the Money?

Article Details
  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 29 October 2018
  • Copyright Protected:
    2003-2018
    Conjecture Corporation
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Close to the money involves a situation where the strike price for the underlying security for an option contract is almost identical to the current market price associated with the option. Generally, the investor will look for investments where strike prices are slightly lower than the current market prices. This approach helps the purchase to be profitable from the moment that the deal is executed.

Considering option contracts that are close to the money can be a relatively lucrative way to acquire options at good prices and generate a consistent return for the investment portfolio. Options that tend to exhibit a market price that is very close to the strike price have a tendency to be very stable, and often are upwardly mobile. While a close to the money option may not ever experience a drastic rise in value, the incremental increase in value over time can make the acquisition well worth the time and effort.

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There is some difference of opinion on how close the strike and market prices have to be in order for the option contract to be considered close to the money. Everyone would tend to agree that an option that has a current market value of $10.00 in United States dollars (USD) and also sports a strike price of $9.90 USD would be a classic close to the money situation. However, many financial experts are of the opinion that if the difference between the two prices exceeds more than fifty cents, the option is more properly considered to be an outside of the money situation.

A close to the money option also carries some degree of benefit when the investor has reason to think that a currently owned option is going to decrease in value in the near future. The investor can sell the close to the money option before the downward trend begins, and thus minimize the amount of loss incurred. In the event that the trend reverses at a later date, the investor can always take a second look and perhaps decide to acquire another option associated with the same underlying security.

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