Option Time Value
In finance, the time value (TV) (extrinsic or instrumental value) of an option is the premium a rational investor would pay over its current exercise value (intrinsic value), based on the probability it will increase in value before expiry. For an American option this value is always greater than zero in a fair market, thus an option is always worth more than its current exercise value. For a European option, the extrinsic value can be negative. As an option can be thought of as ‘price insurance’ (e.g., an airline insuring against unexpected soaring fuel costs caused by a hurricane), TV can be thought of as the risk premium the option seller charges the buyer — the higher the expected risk (volatility • time), the higher the premium. Conversely, TV can be thought of as the price an investor is willing to pay for potential upside.
TV decays exponentially to zero at expiration, with a general rule that it will lose ⅓ of its value during the first half of its life and ⅔ in the second half. As an option moves closer to expiry, moving its price requires an increasingly larger move in the price of the underlying security.
Read more about Option Time Value: Intrinsic Value, Option Value, Time Value
Famous quotes containing the words option and/or time:
“You don’t merely give over your creativity to making a film—you give over your life! In theatre, by contrast, you live these two rather strange lives simultaneously; you have no option but to confront the mould on last night’s washing-up.”
—Daniel Day Lewis (b. 1957)
“The process of education in the oldest profession in the world is like any other educational process, in that it requires time and effort and patience; it can only be acquired by taking one step at a time, though the steps become accelerated after the first few.”
—Madeleine [Blair], U.S. prostitute and “madam.” Madeleine, ch. 4 (1919)