Intrinsic and Extrinsic Value difference for making profit

 

You can trade stock, commodity, index and currency options and profit from changes in an underlying’s price without risking a lot of money. The market price of each option is available on the exchanges and is updated continuously. The option’s market price is also known as its premium price. The premium price always consists of extrinsic value, also known as time value, and may include intrinsic value.

 

When trading options e.g. selling options, it’s important to understand Intrinsic and Extrinsic Value.  It could mean the difference between making money and losing money.

Intrinsic Value

Intrinsic Value is the difference between  a stock market price ( the underlying security)  and the price where the option is trading at. We were looking at Verizon. The stock was trading at $43. We were looking at the call with a strike price of  $41. The intrinsic value is $2.

If you held this call option, you could exercise the option and buy the shares for $41 and immediately sell the shares for $43, pocketing the $2 per share intrinsic value. Options that are out-of or at-the-money have no intrinsic value.

Intrinsic Value

Extrinsic Value

The extrinsic value of an option is the portion of an option price that is not intrinsic value. If the price of the $41 strike call option on the $43 stock is 2.50, the $0.5 above the $2 intrinsic value is the extrinsic value. Out-of-the money and at-the-money option prices consist of only extrinsic value. This value is often referred to as time premium. The time premium is the value in an option’s price that covers the rights given by the option contract in relation to the time until the option expires.

Extrinsic Value

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I hope this article provides you more insight in intrinsic and extrinsic value of an option. It could help you to make profits when you sell option premium. Read also topics like Make Money when Options Expire or How to make money with trading