The price of a Option consists of two components: the intrinsic value and the extrinsic value (also called time value). While the time value decreases continuously until the expiration date and falls to zero, the intrinsic value of the option on the expiration date determines whether a profit is made or whether the option expires worthless. In this article you will learn what the intrinsic value of an option is and how you can use this calculate can.
What is the intrinsic value of an option?
The intrinsic value of an option corresponds to the value of the option it would have had if immediately Exercise has or would have. The intrinsic value is therefore higher the deeper the option is in the money. At The Money and Out Of The Money options have no intrinsic value.
In addition to their intrinsic value, options also have a outer value (time value). This can be understood as the market's premium, which comes about because the option has the potential to run into the money or even deeper into the money during the remaining term (i.e. to acquire or increase an intrinsic value) and market participants are willing to pay a price for this potential.
How to calculate the intrinsic value?
The intrinsic value is the Difference between the price of the underlying and the strike price of the option. However, this can only be calculated for options that are in-the-money, since options that are at-the-money or out-of-the-money have no intrinsic value. (The intrinsic value cannot be negative).
The intrinsic value of a Call option amounts:
Intrinsic value (call) = price underlying - strike price option
The intrinsic value of a Put option amounts:
Intrinsic value (put) = strike price option - underlying price