Intrinsic vs Time Value — Concept Explainer Video

Transcript

Two parts of a premium

For an ordinary stock option, it helps to split the premium into intrinsic value and time value. Intrinsic value measures how far the option is in the money. The remainder is often called time value, or extrinsic value.

Start with the exercise arithmetic

A call with a one hundred dollar strike has eight dollars of intrinsic value when the stock is one hundred eight. For a put, reverse the subtraction: strike minus stock price. Intrinsic value cannot be less than zero.

Find the remainder

If that call trades for eleven dollars, subtract its eight dollars of intrinsic value. The remaining three dollars is extrinsic value. For one standard contract, that is eleven hundred dollars of premium, split into eight hundred and three hundred.

Time value is more than time

Extrinsic value reflects uncertainty, volatility, carry, and the exercise rules, not only the number of days left. For European options, deferred exercise can even make price minus immediate exercise intrinsic negative. The simple nonnegative split is not universal.

Do not confuse value with profit

At expiration, settlement follows the contract payoff and no optional time remains. Profit still depends on the premium you paid or received. An option with intrinsic value can leave its buyer with a loss after that cost.