Intrinsic value of an option can be defined as the extent to which the option is in-the-money (ITM). What do we understand by ITM options? An ITM option is one where the right implicit in the option is valuable purely because the price is favourable. To understand the concept of intrinsic value one also needs to understand the concept of time value of an option. In fact, it is the sum of the time value and the intrinsic value that represents the market price of the option. Time value, as the name suggests, is the price you pay for the expectation that the option price will move further in your favour. For example, ATM options and OTM options do not have any intrinsic value since there is no price advantage for the option in both the cases. Hence the entire premium of the option represents the time value only. If all that sounds a tad confusing, then let us break up this discussion further into call options and put options and understand the intrinsic value of an option in granular detail.

Intrinsic value of an option can be defined as the extent to which the option is in-the-money (ITM). What do we understand by ITM options? An ITM option is one where the right implicit in the option is valuable purely because the price is favourable. To understand the concept of intrinsic value one also needs to understand the concept of time value of an option. In fact, it is the sum of the time value and the intrinsic value that represents the market price of the option. Time value, as the name suggests, is the price you pay for the expectation that the option price will move further in your favour. For example, ATM options and OTM options do not have any intrinsic value since there is no price advantage for the option in both the cases. Hence the entire premium of the option represents the time value only. If all that sounds a tad confusing, then let us break up this discussion further into call options and put options and understand the intrinsic value of an option in granular detail.