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Intrinsic and Time Value
Options have both intrinsic value and time value. Intrinsic value represents the actual difference between the option's strike price and the market price of the underlying security. If an option has a $50 strike price and the stock is selling at $55, the option has $5 of intrinsic value. A holder could exercise the option, purchasing 100 shares of the stock for $50 each. He could then immediately sell the stock in the open market for $55, making a profit of $5 per share.
Options also have time value. An option that has a longer period of time until expiration will have more time value than one with a shorter time until expiration. Using the example above, a three month option may have a time value of $1, bringing the total cost of the option to $6, while a 9 month option may have a time value of $3, bringing the total cost to $8. Time value also depends on the volatility of the underlying security and investors' expectations of future price movements. |
