Options Pricing: Intrinsic Value And Time Value
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 TERMS

Bid Wanted
An announcement by an investor who holds a security that he or ... 
Multibank Holding Company
A company that owns or controls two or more banks. Mutlibank ... 
Short Put
A type of strategy regarding a put option, which is a contract ... 
Wingspread
To maximize potential returns for certain levels of risk (while ... 
Volatility Smile
A ushaped pattern that develops when an option’s implied volatility ... 
Nadex
Nadex stands for the North American Derivatives Exchange, a regulated ...

What is the minimum amount of money that I can invest in a mutual fund?
Learn about investing in mutual funds even with a smaller initial investment; there are many funds available to investors ... 
How do I sign up for a TreasuryDirect account?
Invest in Treasury securities by dealing directly with the U.S. Department of the Treasury online, conveniently managing ... 
How can I get a mutual fund prospectus?
Read and understand the prospectus before investing in a mutual fund. You can obtain a copy from the fund company, your financial ... 
Can I purchase mutual funds for my IRA?
Learn how to invest your IRA assets in mutual funds. Discover a few of the different types of mutual funds available for ...