Time Value

What is time value?

Time value is the portion of an option’s premium that reflects the amount of time remaining until the contract expires and the market’s expectation of future price movement. An option’s premium equals intrinsic value plus extrinsic value; time value is the extrinsic portion that declines as expiration approaches.

Key takeaways

• Time value = Option premium − Intrinsic value.
• More time to expiration generally means higher time value.
• Higher implied volatility usually raises time value because it increases the chance of a favorable move.
• Time decay accelerates as expiration nears; theta measures sensitivity to time decay.
• Exercising an option early often destroys remaining time value, so many holders sell rather than exercise.

Fundamentals

• Premium: the price paid for an option (what buyers pay and sellers receive).
• Intrinsic value: the immediate, in-the-money amount. For a call: max(0, underlying price − strike). For a put: max(0, strike − underlying price).
• Extrinsic value: premium minus intrinsic value. Time value is the extrinsic portion attributable to time and expectations of volatility.

An option with more time until expiration has a greater opportunity to move into profitability, so investors are generally willing to pay more for that time.

How to calculate time value

Basic relationship:
Option premium = Intrinsic value + Time value (extrinsic)

Example:
– Underlying price: $1,044
– Call strike: $950
– Option premium: $97
Intrinsic value = $1,044 − $950 = $94
Time value = $97 − $94 = $3

Factors that affect time value

• Time to expiration: Longer time = more time value.
• Implied volatility (IV): Higher IV increases expected price swings and raises time value.
• Distance from the money: Options at-the-money (ATM) usually have the highest time value; deep ITM or OTM options tend to have less.
• Interest rates and dividends: Minor influences compared with time and IV.

Fast fact: Extending time to expiration or increasing IV both raise the probability that an option finishes in the money, so both increase time value.

Time decay and theta

• Time decay is the loss of time value as expiration approaches; it accelerates over time.
• Theta quantifies the rate at which an option’s price declines due to time decay (usually expressed per day).
• As a rough rule, an option may lose a larger portion of its time value in the second half of its life than in the first; decay typically accelerates as expiration nears.

Practical implications for traders

• Buyers: Pay for time and volatility. If time value is large and you expect little movement or declining volatility, the option can lose value quickly.
• Sellers (writers): Collect time value as income; time decay works in sellers’ favor if the underlying doesn’t move enough to make the option ITM.
• Exercising: Exercising an option early forfeits remaining time value; selling the option is often more valuable unless there are other reasons to exercise (e.g., capture dividends for deep ITM calls).
• Strategy: Manage positions with an eye on time to expiration and implied volatility changes—both drive extrinsic value.

Quick definitions

• Call option: Right (not obligation) to buy the underlying at the strike price before expiration.
• In the money (ITM): Option has intrinsic value (call: underlying > strike; put: strike > underlying).
• Delta: Approximate change in option price for a $1 move in the underlying (e.g., delta 0.15 implies option price changes about $0.15 for a $1 underlying move).
• Theta: Rate of time decay; negative for long option positions (value lost each day).

Conclusion

Time value is a core driver of options pricing. It reflects the value of remaining time and expectations about future volatility. Understanding how time, implied volatility, and theta interact helps traders decide when to buy, sell, or exercise options and how to manage time-related risks.