option pricing-intrinsic value

8/17/2019 Option Pricing-Intrinsic Value

1/4

Options Pricing: Intrinsic Value And Time Valueptions Pricing: Intrinsic Value And Time Value

Options Pricing: Intrinsic Value And Time Valueptions Pricing: Intrinsic Value And Time Value

The two components of an option premium are thehe two components of an option premium are the intrinsic valuentrinsic value and theand the time valueime value. The intrinsic The intrinsic

value is the difference between the underlying's price and the strike price. Specifically, the intrinsicalue 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, thealue 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 pricentrinsic value is the strike price minus the underlying price

Intrinsic Value (Call) = Underlying Price – Strike Pricentrinsic Value (Call) = Underlying Price – Strike Price

Intrinsic Value (Put) = Strike Price – Underlying Pricentrinsic Value (Put) = Strike Price – Underlying Price

By definition, the only options that have intrinsic value are those that arey definition, the only options that have intrinsic value are those that are in-the-moneyn-the-money. For calls, in- For calls, in-

the-money refers to options where the exercise (or strike) price is less than the current underlyinghe-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.rice. A put option is in-the-money if its strike price is greater than the current underlying price.

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

In-the-Money (Put) = Strike Price > Underlying Pricen-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,ny 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 sellerssume 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 theeceives, $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).ption has an intrinsic value of $7.00, its time value would be $2.00 ($9.00 - $7.00 = $2.00).

Time Value = Premium – Intrinsic Valueime Value = Premium – Intrinsic Value

In general, the more time to expiration, the greater the time value of the option. It represents then 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 inmount 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 timehe 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 likelihoodassuming 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 athat the position can become profitable. Time value decreases over time and decays to zero at

expiration. This phenomenon is known asxpiration. This phenomenon is known as time decayime decay.

An option premium, therefore, is equal to its intrinsic value plus its time value.n option premium, therefore, is equal to its intrinsic value plus its time value.

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

Byy

Jeanean

Folgerolger

Maximize your profits in up and doaximize your profits in up and down

markets by subscribing to thearkets by subscribing to the

Chartadvisorhartadvisor newsletternewsletter

Enter e-mail addressnter e-mail address Sign Up

See all newslettersee all newsletters

Market Capitalizationarket Capitalization

Cash Conversion Cycle - CCCash Conversion Cycle - CCC

Rule Of 72ule Of 72

Deferred Interesteferred Interest

Goodwilloodwill

Return On Invested Capital - ROICeturn On Invested Capital - ROIC

HOT DEFINITIONSOT DEFINITIONS

Trading Centerrading Center

SHAREHARE

Topics Reference Simulator

Advisor Insights

Search Investopedi Newsletters

http://www.investopedia.com/university/options-pricing/option-price-influence.asphttp://www.investopedia.com/university/options-pricing/option-price-influence.asphttp://www.investopedia.com/contributors/393/http://www.investopedia.com/http://www.investopedia.com/topics/http://www.investopedia.com/dictionary/http://www.investopedia.com/simulator/http://www.investopedia.com/university/options-pricing/option-price-influence.asphttp://www.investopedia.com/accounts/signupnewsletter/?subid=header&source=headerhttp://www.investopedia.com/advisor-network/http://www.investopedia.com/simulator/http://www.investopedia.com/dictionary/http://www.investopedia.com/topics/http://www.investopedia.com/http://googleads.g.doubleclick.net/pcs/click?xai=AKAOjsuC6UO1-zUfLjwLsGwuAsiR5vlL_X454LYO6lm-o4-lA9h5Q9dImV8dUPOlRcER5RH21xuiWN2BmCR8nBs94DOi05u8vS1uMrM1OtV_KqUqrShbj6-UpYshUGCVR8ciAsmapJl13aMAiCJr2NQBoYS2oyLFSFD4XKsoztPDa4TwmkESGnoRpoQzc2Qpohx2JlhFJWZqPt_FJpebQvji9LALrXA_2UB1t3TJ8EWnfq77EusK9eYe6bMcvk5B55nv2EJdKgUq&sai=AMfl-YTCWhFlh8e9p2eGrheffbcG5VGdlay9KT_glsqwxm8cwER3a4p8te8VkyM7HdetoXXMXMiSXztU3w&sig=Cg0ArKJSzATvZ8RoKpu6&adurl=http://www.investopedia.com/accounts/signupnewsletter/%3Fsubid%3Ddfp-button%26source%3Ddfp-buttonhttp://www.investopedia.com/accounts/signupnewsletter/?list=cotwhttp://www.investopedia.com/terms/r/returnoninvestmentcapital.asphttp://www.investopedia.com/terms/g/goodwill.asphttp://www.investopedia.com/terms/d/deferredinterest.asphttp://www.investopedia.com/terms/r/ruleof72.asphttp://www.investopedia.com/terms/c/cashconversioncycle.asphttp://www.investopedia.com/terms/m/marketcapitalization.asphttp://www.investopedia.com/contributors/393/http://www.investopedia.com/university/options-pricing/modeling.asphttp://www.investopedia.com/university/options-pricing/option-premiums-theoretical-value.asphttp://www.investopedia.com/university/options-pricing/option-price-influence.asphttp://www.investopedia.com/terms/t/timedecay.asphttp://www.investopedia.com/terms/i/inthemoney.asphttp://www.investopedia.com/terms/t/timevalue.asphttp://www.investopedia.com/terms/i/intrinsicvalue.asphttps://twitter.com/intent/tweet?text=&url=http%3A%2F%2Fwww.investopedia.com%2Funiversity%2Foptions-pricing%2Fintrinsic-value-time-value.asp%3Futm_source%3Dtwitter%26utm_medium%3Dsocial%26utm_campaign%3Dshareurlbuttonshttps://www.facebook.com/dialog/share?app_id=371867692868423&display=popup&href=http%3A%2F%2Fwww.investopedia.com%2Funiversity%2Foptions-pricing%2Fintrinsic-value-time-value.asp%3Futm_source%3Dfacebook%26utm_medium%3Dsocial%26utm_campaign%3Dshareurlbuttons&redirect_uri=http%3A%2F%2Fwww.investopedia.com%2Fmisc%2Fcallback%2Ffacebook%2F


2/4

Next:ext Options Pricing: Factors That Influence Option Priceptions Pricing: Factors That Influence Option Price

Option Premium = Intrinsic Value + Time Valueption Premium = Intrinsic Value + Time Value

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

RETIREMENTETIREMENT

Roth IRAs Tutorialoth IRAs TutorialBy Denise Applebyy Denise Appleby

ACTIVE TRADING FUNDAMENTALSCTIVE TRADING FUNDAMENTALS

Guide to Short Sellinguide to Short SellingBy Elvis Picardo, CFAy Elvis Picardo, CFA

OPTIONS & FUTURESPTIONS FUTURES

Introduction to Options Typesntroduction to Options TypesBy Ian Harveyy Ian Harvey

BONDS & FIXED INCOMEONDS FIXED INCOME

Investing For Safety and Income Tutorialnvesting For Safety and Income TutorialBy Brian Perryy Brian Perry

ECONOMICSCONOMICS

American Depositary Receipt Basicsmerican Depositary Receipt BasicsBy Investopedia Staff y Investopedia Staff

RELATED TUTORIALSELATED TUTORIALS

Time Valueime ValueThe portion of an option's premium that ishe portion of an option's premium that is

attributable to the ...ttributable to the ...

Intrinsic Valuentrinsic ValueIntrinsic value is the actual value of a companyntrinsic value is the actual value of a company

or an asset ...r an asset ...

Large-Value Stockarge-Value StockA type of large-cap stock investment where the type of large-cap stock investment where the

intrinsic value ...ntrinsic value ...

Option Premiumption Premium1. The income received by an investor who sells. The income received by an investor who sells

or "writes" an ...r "writes" an ...

Out Of The Money - OTMut Of The Money - OTMA call option with a strike price that is higher call option with a strike price that is higher

than the market ...han the market ...

Deep Out Of The Moneyeep Out Of The MoneyAn option with a strike price that is significantlyn option with a strike price that is significantly

above (for ...bove (for ...

RELATED TERMSELATED TERMS

ELATED FAQS

http://www.investopedia.com/terms/d/deep-out-of-the-money.asphttp://www.investopedia.com/terms/o/outofthemoney.asphttp://www.investopedia.com/terms/o/option-premium.asphttp://www.investopedia.com/terms/l/large_value_stock.asphttp://www.investopedia.com/terms/i/intrinsicvalue.asphttp://www.investopedia.com/terms/t/timevalue.asphttp://www.investopedia.com/contributors/79/http://www.investopedia.com/university/adr/?rp=ihttp://www.investopedia.com/contributors/281/http://www.investopedia.com/university/safety-and-income/?rp=ihttp://www.investopedia.com/contributors/53325/http://www.investopedia.com/university/day-trading-part-i-intro-options-types/http://www.investopedia.com/contributors/290/http://www.investopedia.com/university/shortselling/http://www.investopedia.com/contributors/84/http://www.investopedia.com/university/retirementplans/rothira/http://www.investopedia.com/university/adr/?rp=ihttp://www.investopedia.com/university/safety-and-income/?rp=ihttp://www.investopedia.com/university/day-trading-part-i-intro-options-types/http://www.investopedia.com/university/shortselling/http://www.investopedia.com/university/retirementplans/rothira/http://www.investopedia.com/university/options-pricing/modeling.asphttp://www.investopedia.com/university/options-pricing/option-premiums-theoretical-value.asphttp://www.investopedia.com/university/options-pricing/option-price-influence.asphttp://www.investopedia.com/university/options-pricing/option-price-influence.asp


3/4

CONTENT LIBRARYONTENT LIBRARY

Articlesrticles Termserms Videosideos Guidesuides Slideshowslideshows FAQsAQs Calculatorsalculators Chart Advisorhart Advisor Stock Analysistock Analysis

Stock Simulatortock Simulator FXtraderXtrader Exam Prep Quizzerxam Prep Quizzer Net Worth Calculatoret Worth Calculator

CONNECT WITH INONNECT WITH INVESTOPE

DICTIONARY:ICTIONARY: # A B C D E F G H I J K L M N O P Q R S T U V W X

Search Investopediaearch Investopedia Symbolymbol

BROWSE BY TOPIC:ROWSE BY TOPIC:

Beginning Investoreginning Investor Option Pricingption Pricing Optionsptions

Recommended byecommended by

Q:: What role does intrinsic value play in put options?hat 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 theee why the concept of intrinsic value is so important in options trading and how investors use it to evaluate the

worth ...orth ... Read Answer >>ead Answer >>

Q:: What role does intrinsic value play in call options?hat 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 estimatenderstand why the concept of intrinsic value is important for options traders and how they can use it to estimate

what a ...hat a ... Read Answer >>ead Answer >>

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

Learn more about the moneyness of stock options and what happens when the underlying security's priceearn more about the moneyness of stock options and what happens when the underlying security's price

reaches the option ...eaches the option ... Read Answer >>ead Answer >>

Q:: When is a call option considered to be "in the money"?hen 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 stockearn about call options, their intrinsic values and why a call option is in the money when the underlying stock

price is ...rice is ... Read Answer >>ead Answer >>

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

exercised ...xercised ... Read Answer >>ead Answer >>

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

picking a ...icking a ... Read Answer >>ead Answer >>

RELATED FAQSELATED FAQS

YOU MAY ALSO LIKEOU MAY ALSO LIKE SPONSORED CONTENTPONSORED CONTENT

Top 10 Most Wonderfulop 10 Most Wonderful

Places in The Worldlaces in The World

Viral Shareiral Share

Top 10 Naturallyop 10 Naturally

Amazing Places in Themazing Places in The

Worldorld

World Listorld List

10 Most Awesome0 Most Awesome

Places in The Worldlaces in The World

Top 10op 10

Top 7 best businessop 7 best business

smartphones in the UKmartphones in the UK

in 2016n 2016

University of ilorin Studentniversity of ilorin StudentPortalortal

Banking is changing ‐anking is changing

are you ready for it?re you ready for it?

Turner Broadcasting Systemurner Broadcasting SystemInc.nc.

5 Bootstrapping Bootstrapping

Strategies Everytrategies Every

Startup Should Be…tartup Should Be…

Unusual Business Ideas Thatnusual Business Ideas ThatWorkork

Slack Alternatives: 10lack Alternatives: 10

Best Tools For Teamest Tools For Team

Communicationommunication

Webiotebiot

5 Best Free Team Best Free Team

Management Toolsanagement Tools

Webiotebiot

http://www.webiot.com/5-best-free-team-management-tools/http://www.webiot.com/slack-alternatives-10-best-tools-for-team-communication/http://uncommonbusiness.blogspot.com/2015/12/5-bootstrapping-strategies-every.htmlhttp://advertisementfeature.cnn.com/2016/huawei/?banking-revolution&cid=apac_adcontent_outbrain_desktop_huaweihttp://www.unilorinadmission.org.ng/top-7-best-business-smartphones-in-the-uk-in-2016/http://top10.kleanar.com/archives/63?happinesshttp://worldlist.adspick.com/top-10-naturally-amazing-places-world-2/?amazingpl4345http://viralshare.gq/archives/501?wonderfulplacehttp://www.investopedia.com/ask/answers/012015/do-you-always-have-consider-intrinsic-value-when-purchasing-stock-why-or-why-not.asphttp://www.investopedia.com/ask/answers/012015/do-you-always-have-consider-intrinsic-value-when-purchasing-stock-why-or-why-not.asphttp://www.investopedia.com/ask/answers/051115/how-do-i-change-my-strike-price-once-trade-has-been-placed-already.asphttp://www.investopedia.com/ask/answers/051115/how-do-i-change-my-strike-price-once-trade-has-been-placed-already.asphttp://www.investopedia.com/ask/answers/042215/when-call-option-considered-be-money.asphttp://www.investopedia.com/ask/answers/042215/when-call-option-considered-be-money.asphttp://www.investopedia.com/ask/answers/051115/what-happens-when-security-reaches-its-strike-price.asphttp://www.investopedia.com/ask/answers/051115/what-happens-when-security-reaches-its-strike-price.asphttp://www.investopedia.com/ask/answers/011215/what-role-does-intrinsic-value-play-call-options.asphttp://www.investopedia.com/ask/answers/011215/what-role-does-intrinsic-value-play-call-options.asphttp://www.investopedia.com/ask/answers/122414/what-role-does-intrinsic-value-play-put-options.asphttp://www.investopedia.com/ask/answers/122414/what-role-does-intrinsic-value-play-put-options.asphttp://www.outbrain.com/what-is/default/enhttp://www.investopedia.com/tags/options/http://www.investopedia.com/tags/option_pricing/http://www.investopedia.com/tags/beginning_investor/http://www.investopedia.com/terms/x/http://www.investopedia.com/terms/w/http://www.investopedia.com/terms/v/http://www.investopedia.com/terms/u/http://www.investopedia.com/terms/t/http://www.investopedia.com/terms/s/http://www.investopedia.com/terms/r/http://www.investopedia.com/terms/q/http://www.investopedia.com/terms/p/http://www.investopedia.com/terms/o/http://www.investopedia.com/terms/n/http://www.investopedia.com/terms/m/http://www.investopedia.com/terms/l/http://www.investopedia.com/terms/k/http://www.investopedia.com/terms/j/http://www.investopedia.com/terms/i/http://www.investopedia.com/terms/h/http://www.investopedia.com/terms/g/http://www.investopedia.com/terms/f/http://www.investopedia.com/terms/e/http://www.investopedia.com/terms/d/http://www.investopedia.com/terms/c/http://www.investopedia.com/terms/b/http://www.investopedia.com/terms/a/http://www.investopedia.com/terms/1/http://www.linkedin.com/company/investopedia-ulchttp://twitter.com/#!/investopediahttp://www.facebook.com/Investopediahttp://www.investopedia.com/net-worth/http://www.investopedia.com/exam-prep-quizzes/http://www.investopedia.com/fxtrader/http://www.investopedia.com/simulator/http://www.investopedia.com/markets/stock-analysis/http://www.investopedia.com/active-trading/chartadvisor/http://www.investopedia.com/calculator/http://www.investopedia.com/ask/http://www.investopedia.com/slide-show/http://www.investopedia.com/university/http://www.investopedia.com/video/http://www.investopedia.com/dictionary/http://www.investopedia.com/articles/http://www.investopedia.com/


4/4

WORK WITH INVESTOPEDIAORK WITH INVESTOPEDIA

About Usbout Us Advertise With Usdvertise With Us Write For Usrite For Us Contact Usontact Us Careersareers

GET FREE NEET FREE NEWSLETTE

Neewsletters

© 2016, Investopedia, LLC. 2016, Investopedia, LLC. All Rights Reservedll Rights Reserved Terms Of Useerms Of Use Privacy Policyrivacy Policy
http://www.investopedia.com/corp/privacypolicy.aspxhttp://www.investopedia.com/corp/termsofuse.aspxhttp://www.investopedia.com/corp/copyright.aspxhttp://www.investopedia.com/accounts/signupnewsletter/?subid=footer&source=footerhttps://careers.smartrecruiters.com/IAC/investopediahttp://www.investopedia.com/corp/contactus.aspxhttp://www.investopedia.com/corp/contactus.aspx?type=WriterSubmissionhttp://www.investopedia.com/corp/advertise.aspxhttp://www.investopedia.com/corp/about.aspx

option pricing-intrinsic value

Documents