Module 8 · Lesson 2 of 13 · Options · About 5 minutes
Option Premium: Intrinsic Value, Time Value and Moneyness
On this page
Before you read: Options Basics: Calls, Puts, Strikes and Expiration
What you will learn
- How an option’s premium splits into intrinsic value and time value.
- What in the money, at the money and out of the money mean (moneyness).
- Which factors raise or lower an option’s price, and why time value shrinks toward expiration.
What is intrinsic value?
If an option expired this very second, what would it be worth?
Intrinsic value is what an option would be worth if exercised right now, and never less than zero.
- Call intrinsic value = underlying price − strike, if positive; otherwise zero.
- Put intrinsic value = strike − underlying price, if positive; otherwise zero.
With a fictional stock at $52, a $50 call has $2 of intrinsic value and a $55 call has none. A $55 put has $3 of intrinsic value and a $50 put has none.
What is moneyness?
How do traders describe where a strike sits relative to the price?
- In the money (ITM). The option has intrinsic value. Calls with strikes below the price; puts with strikes above it.
- At the money (ATM). The strike is at or very near the current price.
- Out of the money (OTM). The option has no intrinsic value. Calls with strikes above the price; puts with strikes below it.
What is time value?
Why would anyone pay for an option that has no intrinsic value at all?
Time value is everything in the premium above intrinsic value:
Premium = intrinsic value + time value
If the $55 call on our $52 stock costs $0.80, all $0.80 is time value. Buyers pay it for the chance that the price moves past the strike before expiration. Time value is usually largest for at-the-money options, smaller for options deep in or far out of the money, and it falls to zero at expiration, when only intrinsic value remains. The shrinking of time value as the days pass is often called time decay.
Premium diagram
Illustrative diagram constructed for teaching. Not real market data.
The diagram shows fictional call premiums across strikes, with the intrinsic part and the time-value part shaded separately; time value is largest near the at-the-money strike. It is constructed for teaching and is not real market data.
What moves an option’s price?
If the underlying does not move at all, can the option’s price still change?
Yes. Pricing models take a handful of inputs, and the premium changes when any of them change:
| Input | Effect on a call (others unchanged) | Effect on a put (others unchanged) |
|---|---|---|
| Underlying price rises | Usually rises | Usually falls |
| More time to expiration | Usually rises | Usually rises |
| Higher implied volatility | Rises | Rises |
| Higher interest rates | Small rise | Small fall |
| Larger expected dividends (stock options) | Small fall | Small rise |
The middle two rows explain why an option can lose value even when the underlying moves the “right” way: if time passes and implied volatility drops, those effects can outweigh the price move.
What this does not tell you about premium
- Model prices are estimates based on assumptions. Real quotes reflect supply and demand and can differ from any model.
- This lesson does not say whether any option is cheap or expensive.
- American-style options can be exercised early in some situations, especially around dividends, which this lesson does not cover in detail.
- Costs and bid/ask spreads reduce what you actually receive or pay.
Check yourself
- A fictional stock is at $80. What is the intrinsic value of a $75 call and of a $75 put? Hint: a value is never negative.
- The $75 call costs $6.10. How much of that is time value? Hint: premium minus intrinsic value.
- The underlying stays exactly where it is for a week. What usually happens to the time value of an at-the-money option, and why? Hint: less time left for a move.
Reflect on your own process
- When you record an option in your journal, do you split its premium into intrinsic and time value, and how do you check the numbers?
- Which pricing inputs does your written review list, and which one did you overlook most often in past entries?
- How would you confirm a model price on your platform against a live quote before noting it in your plan?