Options Pricing: Intrinsic Value And Time Value

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4. Options Pricing: Intrinsic Value And Time

Value
5. Options Pricing: Factors That Influence Option
Price
6. Options Pricing: Distinguishing Between Option
Premiums And Theoretical Value
7. Options Pricing: Modeling

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Options Pricing: Intrinsic
Value And
Time Value

By
Jean
Folger

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The two components of an option premium are the intrinsic value and the time value.
value. The intrinsic
value is the difference between the underlying's price and the strike price. Specifically, the intrinsic
value for a call option is equal to the underlying price minus the strike price; for a put option, the
intrinsic value is the strike price minus the underlying price

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Intrinsic Value (Call) = Underlying Price Strike Price

HOT DEFINITIONS

Intrinsic Value (Put) = Strike Price Underlying Price

Market Capitalization

By definition, the only options that have intrinsic value are those that are in-the-money
in-the-money.. For calls, inthe-money refers to options where the exercise (or strike) price is less than the current underlying
price. A put option is in-the-money if its strike price is greater than the current underlying price.

Cash Conversion Cycle - CCC

Rule Of 72
Deferred Interest
Goodwill

In-the-Money (Call) = Strike Price < Underlying Price

Return On Invested Capital - ROIC

In-the-Money (Put) = Strike Price > Underlying Price

Any premium that is in excess of the option's intrinsic value is referred to as time value. For example,
assume a call option has a total premium of $9.00 (this means that the buyer pays, and the seller
receives, $9.00 for each share of stock or $900 for the contract, which is equal to 100 shares). If the
option has an intrinsic value of $7.00, its time value would be $2.00 ($9.00 - $7.00 = $2.00).
Time Value = Premium Intrinsic Value
In general, the more time to expiration, the greater the time value of the option. It represents the
amount of time that the option position has to become more profitable due to a favorable move in
the underlying price. In general, investors are willing to pay a higher premium for more time
(assuming the different options have the same exercise price), since time increases the likelihood
that the position can become profitable. Time value decreases over time and decays to zero at
expiration. This phenomenon is known as time decay.
decay.
An option premium, therefore, is equal to its intrinsic value plus its time value.

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Option Premium = Intrinsic Value + Time Value

Next: Options Pricing: Factors That Influence Option Price

4. Options Pricing: Intrinsic Value And Time

Value
5. Options Pricing: Factors That Influence Option
Price
6. Options Pricing: Distinguishing Between Option
Premiums And Theoretical Value
7. Options Pricing: Modeling

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RELATED TERMS
Time Value

Intrinsic Value

Large-Value Stock

Option Premium

Out Of The Money - OTM

Deep Out Of The Money

The portion of an option's premium that is

attributable to the ...

A type of large-cap stock investment where the

intrinsic value ...

A call option with a strike price that is higher

than the market ...

RELATED FAQS

Intrinsic value is the actual value of a company

or an asset ...

1. The income received by an investor who sells

or "writes" an ...

An option with a strike price that is significantly

above (for ...

RELATED FAQS
Q: What role does intrinsic value play in put options?
See why the concept of intrinsic value is so important in options trading and how investors use it to evaluate the
worth ... Read Answer >>

Q: What role does intrinsic value play in call options?

Understand why the concept of intrinsic value is important for options traders and how they can use it to estimate
what a ... Read Answer >>

Q: What happens when a security reaches its strike price?

Learn more about the moneyness of stock options and what happens when the underlying security's price
reaches the option ... Read Answer >>

Q: When is a call option considered to be "in the money"?

Learn about call options, their intrinsic values and why a call option is in the money when the underlying stock
price is ... Read Answer >>

Q: How do I change my strike price once the trade has been placed already?
Learn how the strike prices for call and put options work, and understand how different types of options can be
exercised ... Read Answer >>

Q: Do you always have to consider intrinsic value when purchasing a stock? Why or why ...
Take a deeper look at why value investors consider a stock's intrinsic value an important consideration before
picking a ... Read Answer >>

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