The Intrinsic Value of an Option

The intrinsic value of an option is the portion of the price of the option attributable to being in the money. The amount the option is in the money is therefore equal to the intrinsic value, as shown by the following formulas:

Intrinsic value for a call = future price - strike price

Intrinsic value for a put = strike price - future price

The intrinsic value of Robert's call is:

          Intrinsic value of call = 98 - 100

                                         = -2 or no intrinsic value

If an option has a negative or zero intrinsic value, we usually say it has no intrinsic value. The intrinsic value of Susan's put is:

        Intrinsic value of put = 100 - 98

                                       = 2

The extrinsic value is the portion of the price of the option which is not dependent on being in the money. The extrinsic value for a call or put is:

Extrinsic value = price of the option - intrinsic value

 

Assume Robert paid $3 for his call and Susan paid $4 for her put. The extrinsic value for Robert's call is:

Extrinsic value = $3 - 0

                      = $3

The extrinsic value of Susan's put is:

Extrinsic value = $4 - 2

                      = $2

The extrinsic value may be positive, negative, or zero. Most options usually have a positive extrinsic value. Some deep in the money options may have a negative extrinsic value, partly because it is often more efficient to buy or sell the future than the option. In the money options near expiration may often have an extrinsic value near zero because they are somewhat of a proxy for the future. The extrinsic value is a function of various factors, such as the volatility of the underlying contract and the time to expiration of the option.