Time value (options)
Also known as: extrinsic value, time premium
The time value of an option is the part of its premium that exceeds its intrinsic value. It represents what buyers will pay for the chance that the option moves further into the money before it expires.
Every option premium splits into two pieces: intrinsic value, the amount by which the option is already in the money, and time value, everything else. The relationship is simply premium = intrinsic value + time value, so time value = premium − intrinsic value.
A concrete example makes the split clear. Suppose XYZ trades at $52 and an XYZ 50 call is quoted at $4. The call is $2 in the money, so intrinsic value is $2 and the remaining $2 is time value. If the same option had a premium of $2 with the stock at $52, it would carry no time value at all. An out-of-the-money option has zero intrinsic value, which means its entire premium is time value.
Time value erodes as expiration approaches, a process called time decay. The decay is not linear — it accelerates in the final weeks — and at expiration time value reaches zero, leaving only intrinsic value. Time value is also larger when the underlying security is more volatile, because greater price swings raise the odds that the option finishes deeper in the money. This is why option buyers are hurt by the passage of time while option writers benefit from it.
The Series 7 exam expects you to break a given premium into intrinsic value and time value quickly, and to recognize that a long option position loses value as expiration nears. The broader idea that money and opportunity are worth more the sooner they arrive also underpins the time value of money material on the Series 66 and the CIMA Certificate in Business Accounting.
Key takeaways
- Time value is the premium of an option minus its intrinsic value.
- An out-of-the-money option's premium is entirely time value; at expiration, time value is zero.
- Time decay accelerates as expiration approaches, hurting option buyers and helping option writers.
- Higher volatility and more time remaining both increase an option's time value.