Options newbies must-read: Intrinsic Value vs Time Value, how to calculate money?

When playing with options, people always talk about “intrinsic value” and “time value”, but what exactly are these two things? Simply put, the price of an option = intrinsic value + time value, it's that simple.

Intrinsic Value: Money That Can Be Earned Now

Intrinsic Value is how much you can earn by exercising the option immediately.

Call Options:

• Formula: Current Price - Strike Price
• Example: A certain stock is currently priced at 60 yuan, the strike price of the call Options is 50 yuan, Intrinsic Value = 60-50 = 10 yuan. If you exercise now, you buy the stock at 50 yuan and immediately sell it at 60 yuan, making a profit of 10 yuan.

Put Options:

• Formula: Strike Price - Current Price
• Example: The current stock price is 45 yuan, the strike price of the put option is 50 yuan, Intrinsic Value = 50-45 = 5 yuan. If you exercise now, you can sell the stock at a price of 50 yuan, which is 5 yuan higher than the market price.

Key Point: Intrinsic Value cannot be negative. If the calculation results in a negative number, it is considered 0. This situation is called “out-of-the-money”, which means a losing trade.

Time Value: Betting on Future Money

Time Value (also known as Extrinsic Value) = Options Total Price - Intrinsic Value

Example: A certain option has a total price of 8 yuan, an intrinsic value of 5 yuan, so the time value = 8 - 5 = 3 yuan.

This 3 yuan is the market betting – there's still time, and perhaps the price can continue to move in a favorable direction.

What Affects Time Value:

• ⏰ Remaining Time: The longer, the more valuable (more opportunities)
• 📊 Volatility: The crazier the market, the higher the time value (the greater the variability)
• 💰 Interest rates and dividends: will also have an impact, but not as obvious as the first two.

Why distinguish between these two?

1. Risk Assessment

• High time value = High risk, great potential
• High Intrinsic Value = Lower Risk, Close to Profit

2. Timing of Transactions

• When options are nearing expiration, the time value decays rapidly (“time decay”)
• Smart Operations: Sell Options when Time Value is High, Buy Options when Time Value is Low

3. Strategy Selection

• Bullish: Buy Call Options
• Bearish outlook: Buy put Options
• Cutting leeks: Selling Options to profit from the decay of time value

Practical Tips

• The pitfall that beginners are most likely to fall into: buying out-of-the-money Options (pure time value) and dreaming of getting rich overnight, only to end up losing nine out of ten times.
• Savvy players: Sell options during high volatility periods to earn money from time decay and volatility decay.
• Time waits for no one: Options lose value every day, you must get the direction and timing right.