Price is what you pay. Value is what you get.
The Two Parts of Option Price
Intrinsic Value
The "real" value if exercised right now. How much the option is in-the-money.
Time Value
Extra premium for the "possibility" of future gains. Shrinks as expiration approaches.
Intrinsic Value Explained
Intrinsic value is simple: it's how much money you'd make if you exercised the option right now.
| Option Type | Intrinsic Value Formula | Example |
|---|---|---|
| Call | Stock Price - Strike Price | $180 stock, $170 strike = $10 intrinsic |
| Put | Strike Price - Stock Price | $170 strike, $160 stock = $10 intrinsic |
Key rule: Intrinsic value can never be negative. If the formula gives a negative number, intrinsic value is $0 (the option is "out of the money").
Time Value Explained
Time value is the extra amount you pay beyond intrinsic value. It represents the possibility that the option could become more valuable before expiration.
Real Example:
Apple stock: $175
Call option with $170 strike: trading at $8.50
Intrinsic value: $175 - $170 = $5.00
Time value: $8.50 - $5.00 = $3.50
You're paying $3.50 extra for the chance Apple goes even higher before expiration.
What Affects Time Value?
Time Until Expiration
More time = more time value. A 90-day option costs more than a 30-day option because there's more time for the stock to move.
Volatility
Wild stocks = expensive options. Tesla options cost more than Coca-Cola options because Tesla moves more.
Distance from Strike Price
At-the-money options (strike = stock price) have the most time value. Deep in/out of the money options have less.
Time Decay: The Silent Killer
Warning: Time value disappears as expiration approaches. This is called time decay or theta decay.
- • Options lose value every day, even if the stock doesn't move
- • Decay accelerates in the final 30 days before expiration
- • At expiration, time value = $0 (only intrinsic value remains)
Putting It Together: Full Example
| Days to Expiry | Stock Price | Intrinsic | Time Value | Option Price |
|---|---|---|---|---|
| 60 days | $175 | $5.00 | $4.50 | $9.50 |
| 30 days | $175 | $5.00 | $2.80 | $7.80 |
| 7 days | $175 | $5.00 | $0.90 | $5.90 |
| Expiration | $175 | $5.00 | $0.00 | $5.00 |
$170 strike call option. Notice how time value shrinks while intrinsic stays the same.