Time Value

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DEFINITION of 'Time Value'

The portion of an option's premium that is attributable to the amount of time remaining until the expiration of the option contract. An option's premium is comprised of two components: its intrinsic value and its time value. The intrinsic value is the difference between the price of the underlying (for example, the underlying stock or commodity) and the strike price of the option. Any premium that is in excess of the option's intrinsic value is referred to as its time value.

BREAKING DOWN 'Time Value'

The price (or cost) of an option is an amount of money known as the premium. An option buyer pays this premium to an option seller in exchange for the right granted by the option: the choice (the "option") to exercise the option or allow it to expire worthless. The premium is equal to the intrinsic value plus the option's time value. The intrinsic value for a call option is equal to the underlying price minus the strike price; the intrinsic value for a put option is equal to the strike price minus the underlying price.

An option's time value is equal to its premium (the cost of the option) minus its intrinsic value (the difference between the strike price and the price of the underlying). As a general rule, the more time that remains until expiration, the greater the time value of the option. This is because investors are willing to pay a higher premium for more time since the contract will have longer to become profitable due to a favorable move in the underlying.

In general, an option loses one-third of its time value during the first half of its life, and the remaining two-thirds of its time value during the second half. Time value decreases over time, eventually decaying to zero at expiration, a phenomenon known as time decay.

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