Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 289

Intrinsic Value - This is the amount that an option is in the money. In our example, FAL has an intrinsic value of $10 and FAI has an intrinsic value of $5 (given that Ford's stock is at $50). The other options in our example have no intrinsic values.

Time Value - Unlike the intrinsic value, time value is the intangible part of an option's price. The time value is the price of the option over and above the intrinsic value based on the amount of time left until expiration. Let's look at this using our example. Ford's stock is trading at $50 and FAJ, strike price $50 expiring in 20 days, is selling for $2. How would you think this price would compare to that of FBJ (February option), strike price $50, expiring in 50 days? Both options are at the money but FAJ has 20 days to go while FBJ has 50 days. You probably guessed that FBJ would be more expensive as it gives the stock more time to appreciate (you are locked in for the $50 exercise price for 50 days rather than 20 days). And you would be correct. FBJ may in fact sell for $3 rather than $2, which is FAJ's price. The extra $1 you pay for FBJ options is for the luxury of gaining the extra 30 days. This is called the time value. The further away the expiration date of an option is from today, the more expensive that option is relative to its shorter-term counterparts. The risk of loss with a long-term option is less than that of a short-term option, hence you pay more for the long-term option.

As you get closer to the expiration day, the time value begins to decrease, following a downward curve format known as time decay. And the closer you get to the expiration date the faster the time value declines, sort of an accelerated decline. If you compare the time values of an option at eight months and then at six months to expiration (given a constant stock price), you may notice a small decline in the time value. But if you make the comparison for the same option at three days and then one day to expiration, you would notice that the time

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Table of Contents
Copyright and Disclaimer
Book Chapters
Table of Contents Copyright and Disclaimer Foreword Money
Bonds Futures Stocks Options
Mutual Funds Retirement Final Words Appendix A

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