Intrinsic & Extrinsic Value

Every option's market price (premium) can be decomposed into two components. Intrinsic value is the amount by which an option is in the money — for a call, it's max(stock price − strike, 0); for a put, it's max(strike − stock price, 0). Extrinsic value (also called time value) is the remaining premium above intrinsic value, representing the probability that the option could gain additional value before expiration. Extrinsic value is influenced by time to expiration, implied volatility, interest rates, and dividends. At-the-money options have the highest extrinsic value, while deep in-the-money options are almost entirely intrinsic value. All out-of-the-money options consist entirely of extrinsic value. Extrinsic value decays to zero at expiration (theta decay), while intrinsic value is realized through exercise or assignment.