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Market Structure

Extrinsic Value (Time Value)

The portion of an option's price that is not intrinsic value. Decays to zero at expiration and is driven by time and implied volatility.

What is extrinsic value?

Extrinsic value, also called time value, is the portion of an option's premium that is not intrinsic value. It is what the market is paying for the chance the option ends up worth more by expiration.

Premium = intrinsic value + extrinsic value. An OTM option's price is 100 percent extrinsic. An ATM option is mostly extrinsic. A deep-ITM option has very little extrinsic value left.

What drives extrinsic value

  • Time to expiration: more time means more chance for the stock to move, so more extrinsic value. As days pass, extrinsic value decays toward zero. See theta.
  • Implied volatility (IV): higher IV means the market expects bigger moves, so extrinsic value is higher. When IV drops, extrinsic value drops with it (see IV crush).

The bleed

At expiration, extrinsic value is zero. Every penny of it that existed when you bought the option has decayed away. That is why buying far-OTM options close to expiration is usually a losing proposition: you are paying pure extrinsic value that will vanish in days.

Related Terms

0DTE (Zero Days to Expiration)

Options that expire the same trading day they are held. Cheap, volatile, and dominated by time decay.

IV Crush

A sharp drop in implied volatility that can cause an option to lose value even when the stock moves in your direction.

Implied Volatility (IV)

A measure of how much the market expects a stock to move, derived from options prices. High IV means the market expects a big move. IV crushes after the event.

Intrinsic Value (Options)

The portion of an option's price that comes from the stock already being past the strike. Zero for out-of-the-money options.

Options

Contracts that give the buyer the right, but not the obligation, to buy or sell a stock at a specific price before a specific date.

Theta (Time Decay)

The amount an option loses in value each day from time passing. Accelerates as expiration approaches.