extrinsic value

finance

Also known as: time value

Written byDoug Ashburn

Fact-checked byThe Editors of Encyclopaedia Britannica

An option’s theta is a reflection of the decay of its extrinsic value.

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Also Known As:: time value

In options trading, extrinsic value—also called time value—is the current market value of uncertainty in the option between now and the option’s expiration. If an option is in the money, the extrinsic value is the amount of the premium over and above its intrinsic value. If an option is currently out of the money, its premium is entirely made up of extrinsic value.

For example, if stock XYZ is trading for $60 per share, and a call option at the 55-strike is trading for $6.25, that option would have $5 of intrinsic value (because the stock is trading exactly $5 above the strike price) and $1.25 of extrinsic value. If a call option at the 65-strike (which is out of the money) is trading for $0.40, it would have $0.40 of extrinsic value.

A rise in an option’s implied volatility (as measured by the variable vega) will raise its extrinsic value. As time passes, all else equal, an option’s value will erode (as measured by the variable theta, also known as “time decay”).

When an option expires, it has zero extrinsic value.

This article was most recently revised and updated by Doug Ashburn