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Educational Article

Time Value vs. Intrinsic Value

HAVING TROUBLE PRINTING?

In the world of options Intrinsic value and time value are parts that make up every option contract that you will buy or sell. To get a better understanding of them both, one needs to have a firm definition as to what they each mean.

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Let's look at the table below and try calculating a few options in relationship to their Time Value and Intrinsic value

Figure 1: Time Value vs. Intrinsic Value.

Now before we figure out each of the option problems above, lets take a look at a couple of formulas that we should remember that will make it very easy to determine Time Value from Intrinsic Value.

FORMULAS:

Call Options: Intrinsic Value = the stock's current price - Call Strike Price
Time Value = Call Premium - Intrinsic Value

Put Options: Intrinsic Value = Put Strike Price - Stock's current Price
Time Value = Put Premium - Intrinsic value

Now let's look at problem #1, if the current price of XYZ is 43, use the table above to calculate the Time Value and the Intrinsic Value of the Jun 45 Call option trading at 2.50.

After you have figured out the answers for #1, do #2 through 5. (Answers below- doesn't look until you have tried them all.)

Notice in #1 that the XYZ Jun 45 Call has NO intrinsic value. Remember that intrinsic value is only associated with options that are IN-THE-MONEY. The XYZ June 45 option is OUT-OF-THE-MONEY, hence has to be entirely made up of Time Value only.
Hence, the answer to #1 has to be 2.50 of Time Value and Nothing of Intrinsic Value.

So how well did you do with the rest?

HINT: If the option is out or at the money the entire option premium is made up of TIME VALUE ONLY.

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