Options Intrinsic Value Vs Time Value

When buying an option, you need to know how much of its price is intrinsic value and how much is time value.

Option Price = Intrinsic Value + Time Value

     Intrinsic value = Stock's Current Price – Call Strike Price

In May, Wal-Mart Stores, Inc.(NYSE:WMT) is traded at $63.50. You believe that the stock is going to rise in price, so you purchase call option.

Call Option with Different Expiration Date...

The asking price for June 60 call is $3.80 per share.

Intrinsic Value = 63.50 - 60.00 = $3.50

Time Value = 3.80-3.50 = $0.30 

The asking price for July 60 call is $4.30 per share.

Intrinsic Value = 63.50 - 60.00 = $3.50

Time Value = 4.30-3.50 = $0.80

You paid $0.30 per share to control this stock for one month, $0.80 per share for two months. The longer the time to expiration, the higher the price of an option.

 Is June 60 call cheaper than July 60 call...

We can't say June option is cheaper than July.  In this case, July Call option has extra one month of life after June call expires. You are paying extra $0.50 (in this example) to have a longer window of opportunity for the upward price movement of stock WMT.  

Same strike price but different Expiration Date in Options...


Just imagine, WMT goes nowhere and remain at $63.50 in June, you will loss $0.30 (time value) per share.  intrinsic value still remains at $3.50 [63.50-60.].

In July the stock start to rise to $68.50 and now the option worth $7.00 per share, if you sell your options  you will gain $2.70 per share [7.00-4.30=2.70].  (Read More>>Why Not Exercising the Option)

Before buying an option, you must ask yourself whether the stock price increase high enough before option expires to overcome the time value and give you profit. If YES, you have a good reason to enter the trade.