Intrinsic Value
Intrinsic value is the portion of an option’s price that comes from the difference between the option’s strike price and the current market price of the underlying asset, when that difference is favourable to the option holder.
● A call option has intrinsic value when the market price is above the strike price. The intrinsic value is the difference between the two.
● A put option has intrinsic value when the market price is below the strike price. Again, the intrinsic value is the difference.
If an option is at the money or out of the money, its intrinsic value is zero - because exercising it right away would not create a profit. In these cases, the option’s price is made up entirely of time value and implied volatility.
Intrinsic value is one of the two key components of an option’s premium, alongside time value.
Why intrinsic value matters to investors
Understanding intrinsic value allows investors to:
● See how much of an option’s price reflects real, exercisable value
● Differentiate between the intrinsic and time value portions of an option’s premium
● Consider decisions about whether to exercise or sell an option
● Evaluate risk and reward associated with different strategies
By separating intrinsic value from time value, investors can better understand what they are actually paying for when they buy options.
However, options are complex financial products that involve significant risk and are not suitable for all investors. Understanding their mechanics, pricing factors, and the potential for loss is essential before considering any trading activity.