Extrinsic Value or Time Value in Option Trading
Extrinsic value, also known as time value, is the portion of an option's premium that is attributed to the time remaining until the option's expiration date. It is the value that an option buyer is willing to pay in anticipation of the option's price moving favorably before it expires.
To better understand the extrinsic value, let's take an example of an option chain for a hypothetical stock CAPITALDC:
Suppose the current market price of stock CAPITALDC is ₹100. The call option with a strike price of ₹100 has an intrinsic value of zero, because ATM (At-The-Money) strick has an intrinsic value of 0, as exercising the option would not result in a profit. However, it still has a positive premium of ₹2.60, which indicates that the buyer is willing to pay for the time value of the option. The extrinsic value of this call option is ₹2.60 - ₹0 = ₹2.60.
On the other hand, the put option with a strike price of ₹100 also has an extrinsic value, as exercising the option would result in a loss. The extrinsic value of this put option is ₹2.00 - ₹0 = ₹2.00.
The extrinsic value of an option gradually decreases as it approaches to its expiration date, as the time remaining for the option to move in the buyer's favor decreases. Therefore, options with longer expiration dates typically have higher extrinsic values than options with shorter expiration dates, all else being equal.
