Intrinsic and time value of an option

When we talk about an option’s price, we might refer to things like the best bid price, best ask price, last trade price (LTP), or even a theoretical price. But there are two other important terms in options pricing that are good to know and understand: intrinsic value and time value.

Intrinsic value

Imagine you hold a call option (long position) on AAPL with a strike price of $240. The current price of AAPL is $247. If you exercise this option right now, you acquire AAPL at $240. You can immediately sell it at the current market price of $247 and make a profit of $7. These $7 represent the intrinsic value of the option.

Now consider that in the example above, you hold an option with a strike price of $250. Is it worth exercising this option? The answer is no, because you would acquire AAPL at a price higher than the market price. In other words, this option is worthless right now. Its intrinsic value is zero.

Summarizing:

Intrinsic value is the amount an option would be worth if it were exercised right now.
For a call option, it’s the difference between the underlying price and the strike price, if the underlying is above the strike.
For a put option, it’s the difference between the strike price and the underlying price, if the underlying is below the strike.
If exercising would not be profitable, the intrinsic value is zero.

Examples:

Example 1 – Strike price is lower than the underlying price:

Stock trades at $247
Call with strike $240 → intrinsic value = $7
Put with strike $240 → intrinsic value = $0

Example 2 – Strike price is higher than the underlying price:

Stock trades at $247
Call with strike $250 → intrinsic value = $0
Put with strike $250 → intrinsic value = $3

Time value

Time value is everything in an option’s price beyond intrinsic value. It reflects the potential for the option to gain value before it expires.

Time value depends on:

Time left to expiration (more time = higher time value)
Expected volatility of the underlying (higher volatility = higher time value)
Interest rates and dividends

Example (continuing Example 2):

If the $250 strike put is priced at $8 in the market, with $3 intrinsic value, then the time value is $5.