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INTRINSIC EXTRINSIC VALUE

Core Concept: Option premium = intrinsic value (profit if exercised now) + extrinsic value (time + volatility).

Why It Matters​

Understanding value composition explains why options decay and how to evaluate fair pricing.

When to Use​

✅ Analyze when:

  • Comparing strikes
  • Evaluating early exercise
  • Choosing expiration dates
  • Assessing if option is expensive

❌ Don't:

  • Ignore extrinsic value when close to expiration
  • Buy high extrinsic value in low-volatility stocks

Key Formulas​

Intrinsic value (calls): Max(Stock Price - Strike, 0)
Intrinsic value (puts): Max(Strike - Stock Price, 0)
Extrinsic value: Option Premium - Intrinsic Value

ITM options: Have intrinsic value
OTM options: 100% extrinsic value (pure time/volatility premium)

Trade-offs​

Intrinsic value: Real profit, stable, doesn't decay
Extrinsic value: Pays for time and uncertainty, decays to $0 at expiration

This concept is foundational to options_basics and explains the theta decay in options_greeks.

Quick Reference​

ScenarioStockStrikePremiumIntrinsicExtrinsic
ITM Call$110$100$12.00$10.00$2.00
ATM Call$100$100$3.00$0.00$3.00
OTM Call$95$100$0.50$0.00$0.50
ITM Put$90$100$11.00$10.00$1.00

Value decay timeline:

90 DTE: 70% extrinsic, 30% intrinsic
45 DTE: 50% extrinsic, 50% intrinsic
15 DTE: 20% extrinsic, 80% intrinsic (ITM options)
0 DTE: 0% extrinsic, 100% intrinsic

Examples​

EXAMPLE

Call option value breakdown:

Stock: $105
110 Call trading at $2.50 (OTM)

  • Intrinsic value: $0 (stock below strike)
  • Extrinsic value: $2.50 (all time value)

Stock moves to $112:

  • Intrinsic value: $2.00 ($112 - $110)
  • Option now trading at $4.50
  • Extrinsic value: $2.50 ($4.50 - $2.00)

Note: Extrinsic stayed same, intrinsic added

Time decay demonstration:

ATM option with 60 DTE, premium = $5.00

  • Intrinsic: $0
  • Extrinsic: $5.00

30 days later (stock unchanged):

  • Intrinsic: $0 (still ATM)
  • Premium: $3.50
  • Extrinsic: $3.50 (decayed $1.50)

At expiration (stock unchanged):

  • Premium: $0 (extrinsic decayed to zero)

Deep ITM vs OTM comparison:

Stock: $100

Deep ITM: 80 Call at $22

  • Intrinsic: $20
  • Extrinsic: $2
  • 91% intrinsic (low theta decay)

OTM: 120 Call at $2

  • Intrinsic: $0
  • Extrinsic: $2
  • 100% extrinsic (high theta decay risk)

Deep ITM behaves more like stock (high delta, low theta).
OTM is pure speculation (decays fast if stock doesn't move). ```

References​