The two components of an option premium are the intrinsic value and the time value. The intrinsic value is the difference between the underlying's price and the strike price. Specifically, the intrinsic value for a call option is equal to the underlying price minus the strike price; for a put option, the intrinsic value is the strike price minus the underlying price
Intrinsic Value (Call) = Underlying Price – Strike Price 
Intrinsic Value (Put) = Strike Price – Underlying Price 
By definition, the only options that have intrinsic value are those that are inthemoney. For calls, inthemoney refers to options where the exercise (or strike) price is less than the current underlying price. A put option is inthemoney if its strike price is greater than the current underlying price.
IntheMoney (Call) = Strike Price < Underlying Price 
IntheMoney (Put) = Strike Price > Underlying Price 
Any premium that is in excess of the option's intrinsic value is referred to as time value. For example, assume a call option has a total premium of $9.00 (this means that the buyer pays, and the seller receives, $9.00 for each share of stock or $900 for the contract, which is equal to 100 shares). If the option has an intrinsic value of $7.00, its time value would be $2.00 ($9.00  $7.00 = $2.00).
Time Value = Premium – Intrinsic Value 
In general, the more time to expiration, the greater the time value of the option. It represents the amount of time that the option position has to become more profitable due to a favorable move in the underlying price. In general, investors are willing to pay a higher premium for more time (assuming the different options have the same exercise price), since time increases the likelihood that the position can become profitable. Time value decreases over time and decays to zero at expiration. This phenomenon is known as time decay.
An option premium, therefore, is equal to its intrinsic value plus its time value.
Option Premium = Intrinsic Value + Time Value 
Related Articles

Trading
What Is Option Moneyness?
Get the basics under your cap before you get into the game. 
Trading
Understanding Option Pricing
Take advantage of stock movements by getting to know these derivatives. 
Trading
What Drives An Option's Price?
The primary drivers of an option’s price are the underlying stock’s current price, the option’s intrinsic value, its time to expiration and volatility. 
Trading
Getting A Handle On The Options Premium
The price of an option, otherwise known as the premium, has two basic components: the intrinsic value and the time value. Understanding these factors better can help the trader discern which ... 
Trading
What Does It Mean When an Option is At The Money?
The strike price of an atthemoney options contract is equal to its current market price. Options that are at the money have no intrinsic value, but may have time value. 
Investing
What Is The Intrinsic Value Of A Stock?
Intrinsic value can be subjective and difficult to estimate. It’s a perception of a security’s value that factors tangible and intangible factors. 
Trading
The Basics Of Option Price
Options can be an excellent addition to a portfolio. Find out how to get started. 
Investing
What Is The Intrinsic Value Of A Stock?
Intrinsic value reduces the subjective perception of a stock's value by analyzing its fundamentals. 
Insurance
Explaining Premiums
Premium has a few different meanings in the financial world.