Intrinsic vs Time Value

Intrinsic vs Time Value

An option's price (called the premium) has two components:

$\text{Option Price} = \text{Intrinsic Value} + \text{Time Value}$

Intrinsic Value

The intrinsic value is the payoff if the option were exercised right now — it's the "real" value based on the current stock price versus the strike.

For a call option: $\text{Intrinsic Value} = \max(S - K, 0)$

An option is:

• In-the-money (ITM): intrinsic value > 0
• At-the-money (ATM): S ≈ K
• Out-of-the-money (OTM): intrinsic value = 0

Time Value

The time value is the extra premium above intrinsic value. It reflects the possibility that the option could become more valuable before expiry.

$\text{Time Value} = \text{Option Price} - \text{Intrinsic Value}$

Time value is always ≥ 0 for a European option. It:

• Decreases as expiry approaches (called theta decay)
• Is highest for ATM options
• Depends on volatility, time to expiry, and interest rates

Example

A call with S = 105, K = 100, market price = 8.00:

• Intrinsic value = max(105 - 100, 0) = 5
• Time value = 8 - 5 = 3