VANILLA OPTIONS : INTRINSIC VALUE  AND TIME VALUE

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THE PREMIUM OF AN OPTION IS THE SUM OF ITS INTRINSIC VALUE AND ITS TIME VALUE.

 

INTRINSIC VALUE: Absolute value of the directional difference between the strike of an option and the underlying market value at a given time. For both puts and calls it is also the value that would be realized if the option expiration was on that date, or for an American option if it was immediately exercised.

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For a call option the intrinsic value is the underlying price minus the option strike, or zero if the underlying value is below the strike.

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For a put option it is the difference between the strike minus the underlying market value, or zero if the underlying is trading above the strike.

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Note that for a given option strike, if a call option has any intrinsic value, the same strike put option will have no intrinsic value. The opposite is also true.

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AT THE MONEY An option which strike is equal to the (current) market price of its underlying;

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IN THE MONEY An option (currently) with intrinsic value

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OUT OF THE MONEY: An option with no Intrinsic Value

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TIME VALUE: Value of an option that can only be realized if the underlying moves. The time value of an option is non-negative and is highest at around at the money options (e.g. at the strike that is equal to today’s price for the underlying).