Intrinsic Value and Time Value Explainer
Intrinsic value is the amount by which immediate exercise is favorable. For a call it is the underlying price above the strike, never less than zero. For a put it is the strike above the underlying price, also floored at zero.
Time value, often called extrinsic value, is the premium remaining after intrinsic value is subtracted. It reflects the possibility of more favorable movement before expiration together with volatility expectations, rates, dividends, supply, demand, and market frictions.
Time value generally declines toward zero as expiration approaches, but the path is not linear. Changes in implied volatility or the underlying can offset or accelerate the passage of time. Far in- or out-of-the-money contracts can behave differently from near-the-money options.
Exercising early can forfeit remaining time value, so selling the option may be economically preferable when a liquid market exists. Dividends, borrow conditions, rates, and assignment risk can still alter the decision. The visible premium should always be decomposed before comparing alternatives.
It cannot be negative.
Calls and puts use opposite price relationships.
Remaining life and expected volatility are major inputs.
Market conditions can change it quickly.
Exercise converts the contract and may discard extrinsic value.
Compare a sale with exercise before acting.
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