Intrinsic Value vs Extrinsic Value: Understanding Option Pricing

Intrinsic Value

Intrinsic value is the "real" or "actual" value of an option—what it would be worth if you exercised it right now.

For Calls: Intrinsic Value = Stock Price - Strike Price (if positive, else 0)

For Puts: Intrinsic Value = Strike Price - Stock Price (if positive, else 0)

Example: Stock at $107. The $100 call has $7 intrinsic value. The $100 put has $0 intrinsic (it's OTM).

Key insight: Only ITM options have intrinsic value. OTM options have zero intrinsic value.

Extrinsic (Time) Value

Extrinsic value is everything in the premium beyond intrinsic value. It represents:

• The possibility the option becomes more valuable
• Time remaining until expiration
• Expected volatility (uncertainty)

Example: Stock at $107. The $100 call trades at $9. Intrinsic = $7. Extrinsic = $9 - $7 = $2.

Why This Matters

For Option Buyers

You're paying for both intrinsic and extrinsic value. The extrinsic portion decays every day (theta decay). You need the stock to move enough to overcome this decay.

For Option Sellers

You profit from extrinsic value decay. Time is on your side. ATM options have the most extrinsic value—that's why premium sellers often target them.

Key Takeaways