Intrinsic Value and Time Value

Intrinsic value and time value are the two broad components often used to think about an option’s price. In this article, time value matters especially because theta erodes it as expiration approaches.

Intrinsic value is the portion of an option’s value tied to how far in-the-money it is, while time value is the remaining value linked to time, uncertainty and the possibility of future price movement before expiration. The article does not set out a formal formula, but it does make the practical distinction clear by focusing on premium, in-the-money outcomes and theta. Time decay, or theta, is described as the erosion of option time value as expiry approaches, and this decay tends to accelerate in shorter-dated options. That matters because an option can lose value over time even if the underlying does not move much. In the playbook, understanding time value helps explain why long options need the move to happen soon enough, while some short-premium positions may benefit when time passes and the option remains out-of-the-money.

• Theta
• Options
• Options Basics