InvestorQ : I have read that time value is an important component of option price. Can you help me understand that better?
Abhi Yadav made post

I have read that time value is an important component of option price. Can you help me understand that better?

Answer
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rhea Babu answered.
1 year ago


The option premium, as we all by now understand, is the price that the buyer pays to the seller for getting the right to buy without the obligation to buy. This option premium has 2 components viz. time value and intrinsic value. The intrinsic value is the price profit while the time value is the probability that the market is assigning to the option becoming profitable. All ITM options will have intrinsic value and time value while OTM options will only have time value. When we say that the option value is diminishing as expiry approaches then we are talking about time value only. That is the concept of theta which is popularly used by option sellers. Let us look at a live illustration to grasp this point better.

Assume that Infosys is quoting at Rs.1000. Let us look at various scenarios of call option strike prices and how the split of time value and intrinsic value is worked out…

Strike Price

Premium

Expiry

ITM/OTM

Intrinsic Val

Time Value

940 Call

115

Jan-2018

ITM

60

45

960 Call

93

Jan-2018

ITM

40

53

980 Call

61

Jan-2018

ITM

20

41

1000 Call

38

Jan-2018

ATM

0

38

1020 Call

29

Jan-2018

OTM

0

29

1040 Call

22

Jan-2018

OTM

0

22

1060 Call

14

Jan-2018

OTM

0

14

From the above table is clear that OTM call options and ATM call options only have time value while ITM options have time value and intrinsic value.