Why does an option cost more than it would pay out today?
You ended the last lesson with a gap: an in-the-money call worth $5 if exercised right now was quoted at more than $5. That gap is not an error, and it is not a fee. It has a name, a cause, and a fixed expiry date.
Every premium splits in two
Premium = intrinsic value + time value
- Intrinsic value is what exercising right now would be worth. For a call, the greater of (spot − strike) or 0. For a put, the greater of (strike − spot) or 0. It can never be negative.
- Time value (also called extrinsic value) is everything else — what the market charges for the chance that the stock moves further in your favour before expiry.
Rearranged, it is a subtraction you can do on any quote:
Time value = premium − intrinsic value
Three contracts, one stock
Stock trading at $110:
| Contract | Premium | Intrinsic | Time value |
|---|---|---|---|
| $105 call | $7.50 | $5.00 | $2.50 |
| $115 call | $2.20 | $0.00 | $2.20 |
| $95 put | $0.60 | $0.00 | $0.60 |
Read the second and third rows carefully: for any out-of-the-money option, every single cent of the premium is time value. There is nothing else in there. You are buying pure possibility, and possibility has an expiry stamped on it.
Where time value is largest
Time value is not spread evenly across strikes. It peaks at the money and falls away in both directions:
- Deep in the money ($80 call with the stock at $110): the outcome is nearly settled — this contract will almost certainly be exercised — so there is little uncertainty left to price. The premium is nearly all intrinsic, and the contract behaves like a leveraged share substitute.
- At the money ($110 call): maximum genuine doubt about which side of the strike the stock finishes. Maximum time value.
- Far out of the money ($150 call): the chance is small, so the price is small, even though it is 100% time value.
The one certainty in options pricing
At expiry, time value is exactly zero. Not small — zero. The premium collapses to intrinsic value and nothing else, because there is no more time in which anything could happen.
That is not a risk or a probability. It is arithmetic with a date attached. Every option ever written converges to intrinsic value at expiry, and the entire time-value component of what you paid is spent along the way. How it is spent — slowly at first, then all at once — is the next lesson.
In the data
An options chain prints premiums, not their split. The chain and the share price are two separate quotes, both below: Apple's chain in the EODHD Terminal, and Apple's own price.
Open AAPL.US — options in the EODHD Terminal
Intrinsic value is the subtraction between them, done by you. If the two quotes are not from the same moment, part of the "time value" you compute is only the share's move between the two quotes, so compare them during market hours, or take both from the same close.
Try it now
Open one expiry of Apple's call chain above, and take the last price in the table as spot.
For five strikes spanning from clearly ITM to clearly OTM, compute intrinsic value by hand, then subtract it from the mid price to get time value.
Line the five time-value numbers up in strike order. You should see them rise toward the money and fall away past it. That hump is the shape of what the market is charging for uncertainty — and the next lesson watches it shrink.