Option Intrinsic Value

When trading options, you need to understand the meaning and the potential profitability of the option’s intrinsic value. Knowing what the intrinsic value is and how it essentially makes up the equity options price is knowledge that can help you to make profitable investments.

There are two basic components that make up the price of a stock option: intrinsic value and extrinsic value. Intrinsic value is also referred to as fundamental value. It is considered to be the value that remains in the stock option when all of its extrinsic value has disappeared because of time decay.

The intrinsic value of an equity option is the value of its underlying security that is actually built into the price of the option. Oftentimes investors purchase equity options for the purpose of the options having intrinsic value. When investors purchase a call option, they do so in hopes of profiting when the price of the underlying stock rises. As the stock price climbs, more of the value of the stock becomes built into the option’s price in the form of intrinsic value.

Unlike extrinsic value – or time value – intrinsic value doesn’t go down over time. Instead, intrinsic value remains as long as the corresponding security’s price does not move. And, when they expire, options are only left with their intrinsic value. When the price of the underlying security moves, however, the intrinsic value also moves up and down, until eventually, if the stock moves out-of-the-money, the intrinsic value drops to zero.

The value of intrinsic value differs for puts and calls as the price of the underlying stock moves. For example, the intrinsic value of a call option will go up as the price of the underlying stock moves above that call option’s strike price. Conversely, the intrinsic value of a put option will go up as the price of the underlying stock drops below the strike price of the put option.

Leave a Reply

Your email address will not be published. Required fields are marked *