An option's time value is the extra premium buyers are willing to pay on top of its intrinsic value, expecting that the underlying's price will be in their favour on expiry day. Time value decreases continuously, eventually becoming zero on expiration.
It is sometimes known as the extrinsic value.
● The longer the time to expiry, the larger the time value will be.
● OTM and ATM options have only time value, while ITM options have both time value and intrinsic value
Examples with Moneyness
Trader A is long a Reliance Industries ITM call at a strike of ₹2,000 with an expiration in 10 days. Currently, the stock is at ₹2,100 and the value of the option is ₹150. This means that theintrinsic valueis ₹100 and the time value is ₹50.
Situation A: On the expiration date, the stock ends at ₹2,500. In this case, the option has ended ITM. Theintrinsic valueand therefore, the value of the call itself will be ₹500. Remember, there is no time value on expiry.
Situation B: The stock finishes at ₹2,000 and the call ends ATM. In this case, the intrinsic value and the time value are both zero.
Situation C: The price ends at ₹1,800 which means the call has ended OTM. Again, the intrinsic value and the time value are again, zero.
The same logic will apply in reverse for the put buyer.
Disclaimer: This information is for educational purposes only. Trading in Futures and Options involves substantial risk and is unsuitable for all investors. Past performance is not indicative of future results. Consult a financial advisor before engaging in such trading activities.
