What Is Time Value in Options? | How Do Options Work?

Time value (also called extrinsic value) is the part of an option’s premium above its intrinsic value. It is what the market pays for the chance that the option becomes more valuable before it expires, and it falls to zero at expiration.

In short: time value = premium - intrinsic value. Out-of-the-money options are made entirely of time value. It is largest when the option is at the money, when there is more time left, and when implied volatility is high, and it tends to shrink faster as expiration approaches.

The formula and an example

Time value = premium - intrinsic value

Maple Widgets Inc. (a hypothetical company) trades at $50.

Option	Premium	Intrinsic value	Time value
$45 call	$6.20	$5.00	$1.20
$50 call	$2.50	$0	$2.50
$55 call	$0.80	$0	$0.80

The at-the-money $50 call has the most time value, because that is where the outcome is most uncertain. Every dollar of its premium is time value, as is every dollar of the $55 call’s. See intrinsic value for the other half of the split.

What drives time value

Time to expiration. More time gives more chance for a large move, so longer-dated options carry more time value.
Implied volatility. When the market expects bigger moves, time value rises. See implied volatility.
Distance from the strike. Time value peaks near the money and shrinks for options deep in or far out of the money.
Interest rates and dividends. Smaller effects that shift calls and puts in opposite directions.

Time decay

Time value erodes as expiration approaches, and the erosion is not even. For an at-the-money option it tends to speed up in the final weeks. The Greek that measures the daily loss is theta, covered with worked numbers in theta and time decay.

Using the $50 call above: if Maple Widgets is still exactly $50 on expiration day, the call’s $2.50 of time value, or $250 per contract, is gone. The buyer loses the whole premium; the writer keeps it.

Why it matters to buyers and writers

Buyers pay time value up front and need the stock to move far enough, fast enough, to overcome it. This is one of the main reasons explored in why most options buyers lose.

Writers collect time value and benefit as it decays, but they carry the risk that a large move overwhelms the premium received.

A note on early exercise

Exercising an American-style option early throws away its remaining time value, because you receive only intrinsic value. That is why early exercise is usually only rational when there is very little time value left, for example just before a dividend.