The two components of an option premium are the intrinsic valueÂ and Â time valueÂ of the option. The intrinsic value is the difference between the underlying's price and the strike price â€“ or the inthemoney portion of the option's premium. Specifically, the intrinsic value of 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.Â
Intrinsic Value (Call) = Underlying Price â€“ Strike Price 
Intrinsic Value (Put) = Strike Price â€“ Underlying Price 
By definition, the only options that have intrinsic value are those that are inthemoney. For calls, inthemoney refers to options where the 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.
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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 its time value. For example, assume a call option has a premium of $9.00 (this means that the buyer pays â€“ andÂ the seller receives â€“ $9.00 for each share of stock, or $900 for the 100share contract). If the option has an intrinsic value of $7.00, its time value would then be $2.00 ($9.00  $7.00 = $2.00).
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Time Value = Premium â€“ Intrinsic Value 
In general, the more time to expiration, the greater the time value of the option. It represents the amount of time the option position has to become profitable due to a favorable move in the underlying price. In most cases, 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 will 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.
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Option Premium = Intrinsic Value + Time Value 
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