Intrinsic Value and and Time Value of Options

Intrinsic Value and Time Value of an Option

Intrinsic Value:

The immediate gain if the option is exercised.

• Formula:
  • Call Option: ( \text{Max}(S_T - K, 0) )
  • Put Option: ( \text{Max}(K - S_T, 0) )

Time Value:

The additional value of the option above its intrinsic value due to the remaining time until expiration.

• Formula: [ \text{Time Value} = \text{Option Price} - \text{Intrinsic Value} ]

Example:

• A call option priced at $15, with a strike price of $40 and a stock price of $50:
  • Intrinsic Value = ( 50 - 40 = $10 )
  • Time Value = ( 15 - 10 = $5 )