Intrinsic Value and Time Value - Page 1 of 2

Intrinsic value and time value are two of the primary determinants of an option's price. Intrinsic value can be defined as the amount by which the strike price of an option is in-the-money. It is actually the portion of an option's price that is not lost due to the passage of time. The following equations will allow you to calculate the intrinsic value of call and put options:

• Call Options: Intrinsic value = Underlying Stock's Current Price - Call Strike Price Time Value = Call Premium - Intrinsic Value
• Put Options: Intrinsic value = Put Strike Price - Underlying Stock's Current Price Time Value = Put Premium - Intrinsic Value

ATM and OTM options don't have an intrinsic component because they do not have any real value. You are simply buying time value which decreases as an option approaches expiration. The intrinsic value of an option is not dependent on the time left until expiration. It is simply an option's minimum value; it tells you the minimum amount an option is worth. Time value is the amount by which the price of an option exceeds its intrinsic value. It is also referred to as extrinsic value and decays over time. In other words, the time value of an option is directly related to how much time an option has until expiration. The more time an option has until expiration, the greater the option's chance of ending up in-the-money. Time value has a snowball effect. If you have ever bought options, you may have noticed that at a certain point close to expiration, the price seems to stop moving anywhere. That's because the time component of price decays exponentially; the closer you get to expiration the more a move in the security is needed to impact price. On expiration day, all an option is worth is its intrinsic value. It's either in-the-money, or it isn't.

Related Articles:

• Understanding Intrinsic and Time Value
• Getting a Handle on Intrinsic and Extrinsic Values

Recommended Product

Platinum Express
Platinum Express combines the power of options analysis with the case of a completely steamlined platform that is easy to navigate and lets you concentrate on what really matters:

• Isolating trading opportunities quickly and easily
• making informed trading decisions
• Boosting overall returns

Try it FREE for 14 days