Time Value of Option

An option’s time value is equal to the option’s premium minus its intrinsic value. The concept of time value of an option is based on the rationale that an option buyer should pay more than its intrinsic value based on the probability of the option expiring in the money,  i.e. its value will increase over the time period. An option’s time value depends upon the moneyness of the option, volatility and the duration of time remaining to exercise the option. The time value of the option decreases as its expiration date approaches and becomes worthless after that date. This phenomenon is known as “time decay”. Higher volatility also gives rise to a higher time value.

For in the money options, time value can be calculated by subtracting the intrinsic value from the option price. Time value decreases as the option goes deeper into the money. For out of the money or at the money options, time value is equal to the option price, as they have zero intrinsic value.