Time Value

Intrinsic value is only half of a premium. Whatever a buyer pays beyond the in-the-money amount is time value, the price of the waiting game before expiration.

What Time Value Is

Time value (also called extrinsic value) is the slice of the premium sitting above intrinsic value. It is what buyers pay for the chance an option gains, or gains more, intrinsic value before it expires.

• Time Value = Premium minus Intrinsic Value. Rearranged from the core identity, premium equals intrinsic value plus time value.
• Example: a call trades at a premium of 8 with intrinsic value of 5, so time value is 3.
• For any out-of-the-money (OTM) or at-the-money (ATM) option, intrinsic value is 0, so the entire premium is time value. Only an in-the-money (ITM) option has premium split across both parts.

Time Decay

The clock only runs one way, and time value erodes as it runs down.

• Time value shrinks as expiration approaches, and that erosion is called time decay.
• At expiration, time value is zero, so premium equals intrinsic value. An expiring option is worth only its in-the-money amount, or nothing at all if it is out-of-the-money.
• All else equal, the buyer loses time value as expiration nears, while the seller (grantor) benefits from that decay.

Think of it this way: time value is like an ice cube the buyer is holding. Every day closer to expiration melts a little more of it, and on the last day it is gone completely, leaving only whatever solid intrinsic value was frozen inside. The seller is the one who pocketed the cube's price up front and roots for it to melt.

Exam Tip: Gotchas

• Time value decays toward zero and is exactly zero at expiration, when premium equals intrinsic value. If a question asks what a call is worth at expiration with futures at 104 and a strike of 100, the answer is its intrinsic value of 4, not 4 plus any leftover time value.

Time Value and Moneyness

Time value is not spread evenly across strikes. It bunches up where the outcome is least certain.

• Time value is greatest for at-the-money options, where uncertainty about finishing in-the-money is highest.
• Deep in-the-money and deep out-of-the-money options carry less time value, because their outcome is more settled.

Exam Tip: Gotchas

• Time value is largest at-the-money, not deep in-the-money. A deep in-the-money option is mostly intrinsic value with little time value left. A common trap assumes the option with the highest premium also holds the most time value, but a rich premium is usually rich because of intrinsic value.