Lesson 4: Why Options Have Time Value
Promise: Understand intrinsic vs extrinsic and why time matters.
Option Price Decomposition
Every option price has two components:
| Component | What It Is | When It Matters |
|---|---|---|
| Intrinsic | Value if exercised now | At expiry, this is all that remains |
| Extrinsic | "Time value" (premium above intrinsic) | Decays as expiry approaches |
Intrinsic Value
Intrinsic value is what the option would be worth if it expired right now:
| Option | Intrinsic Value |
|---|---|
| Call | max(0, S - K) |
| Put | max(0, K - S) |
Examples (BTC spot = $100k):
- $95k call: Intrinsic = max(0, 100k - 95k) = $5k (ITM)
- $105k call: Intrinsic = max(0, 100k - 105k) = $0 (OTM)
- $105k put: Intrinsic = max(0, 105k - 100k) = $5k (ITM)
OTM options have zero intrinsic value but can still have positive prices due to extrinsic value.
Extrinsic Value (Time Value)
Extrinsic value exists because of uncertainty about the future:
Why does extrinsic value exist?
- Time remaining: More time means more chances for the price to move favorably
- Volatility: Higher uncertainty means higher value for the "optionality"
Time value is the price of uncertainty.
See It In Action
Drag the sliders to watch extrinsic value decay as expiry approaches. Move spot to see how intrinsic value changes.
As expiry approaches:
- Extrinsic value → 0 (the orange area shrinks)
- Option value → Intrinsic value (only the green remains)
At expiry, you're left with only intrinsic value. All that "time value" you paid for is gone.
Why OTM Options Cost Money
Even though an OTM option has zero intrinsic value, it still costs money because:
- The underlying could move to make it ITM before expiry
- The market prices this probability
Example:
- BTC = $100k
- $110k call (OTM): Intrinsic = $0
- But the call trades at $1.5k
That $1.5k is pure extrinsic value: the market's assessment of the chance BTC reaches $110k before expiry.
Time Decay Accelerates
Time decay isn't linear. It accelerates as expiry approaches:
This is why selling options near expiry can be risky. If the market moves against you, there's no time value cushion left.
Hypercall Connection
At expiry on Hypercall:
| What Happens | Result |
|---|---|
| Extrinsic → 0 | Only intrinsic value remains |
| Settlement | Calculated using intrinsic formula |
| Cash-settled | You receive/pay the intrinsic value |
At expiry, your P&L is determined purely by intrinsic value using the 30-minute TWAP settlement price. No extrinsic value remains.
Common Mistakes
| Mistake | Correction |
|---|---|
| "OTM = worthless now" | OTM options have extrinsic value before expiry. They're only worthless at expiry if still OTM. |
| Confusing theta with "guaranteed loss" | Time decay is a tendency, but price can rise if spot or IV moves favorably. |
| Ignoring time when comparing options | A longer-dated option costs more because it has more extrinsic value. |
| Expecting linear decay | Time decay accelerates near expiry (covered in Lesson 6: Greeks). |
💡 Tip: Try answering each question yourself before revealing the answer.
See Also
Navigation: ← Lesson 3: Payoff vs P&L | Lesson 5: Implied Volatility →