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Intrinsic Value vs Extrinsic Value
Academy->Intrinsic Value vs Extrinsic Value
Every option premium is made up of two parts:
- Intrinsic Value
- Extrinsic Value
Understanding these two terms helps explain why one option costs more than another.
Intrinsic value is the value an option already has if it were exercised today.
It only exists when an option is In the Money (ITM).
Example:
Stock Price: $27
Call Strike: $25
The option already has $2 of intrinsic value because the stock is trading $2 above the strike price. If a call or put is At the Money (ATM) or Out of the Money (OTM), it has no intrinsic value.
Extrinsic value is everything above the intrinsic value. It represents the value of time and the possibility that the stock price may change before the option expires. Even an option with no intrinsic value can still have extrinsic value. That's why Out of the Money options often still have a premium.
Example:
Suppose a call option is trading for $3.50.
The stock is $27.
The strike price is $25.
Intrinsic Value:
$2.00
Extrinsic Value:
$1.50
Together:
$2.00 + $1.50 = $3.50 Premium
Intrinsic and extrinsic value help explain:
- Why option premiums change.
- Why time affects an option's price.
- Why two options with different strike prices can have different premiums.
Understanding both values makes it easier to compare option contracts.
OptionLogic in Practice
OptionLogic compares option opportunities using premium, ROI, annualized ROI, market structure, and other information.
While the software doesn't separate premiums into intrinsic and extrinsic value, understanding these concepts helps explain why different contracts are priced differently.
Frequently Asked Questions
Can an option have only extrinsic value?
Yes. ATM and OTM options contain only extrinsic value because they have no intrinsic value.
Does intrinsic value change?
Yes. Intrinsic value changes whenever the stock price moves.
What happens to extrinsic value as expiration approaches?
Extrinsic value generally becomes smaller as the expiration date gets closer.
Which options have the most intrinsic value?
Deep In the Money options usually have the greatest intrinsic value.
Why do Out of the Money options still cost money?
Because there is still time for the stock price to move before expiration. That remaining possibility creates extrinsic value.
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