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Time Value & Intrinsic Value

When an option is in the money it is said to have intrinsic value, and when the contract is out of the money it has no intrinsic value. When an option expires out of the money, traders will say that contract has “expired worthless”. Intrinsic value is the value of the option if it expired at this moment.

Up to this point we described the value of an option contract at the point of expiration, but what is the value of the contract before expiration?

The value of an option is comprised of two parts, the intrinsic value and the time value. When added together, they give you the “option value”.

Option Value = Intrinsic Value + Time Value

When an option contract expires, the time value would be zero. At this point the option value is equal to the intrinsic value.

Option Value = Intrinsic Value + 0

Let’s look at an example when the option has time value greater than zero. Suppose a call option will expire in one month. Here the option value will be higher than the intrinsic value. Even as the futures contract price moves around, the option value will still be greater than the intrinsic value, and that difference is the time value.

As time moves towards expiration, the time value shrinks or decays. The time value of an option (before its expiration date) will always be greatest when the option is at the money.

You can see the entire option value will always be greater than the intrinsic value until it reaches expiration.

There you have it, you now know how to use terms like moneyness, time value, and intrinsic value to express the value a put or call option.

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