Beginner · 6 min read

Premium, moneyness and time value

Why an option costs what it costs: intrinsic value, time value, and ITM / ATM / OTM.

An option's premium has two parts: intrinsic value and time value.

Intrinsic value

Intrinsic value is what the option would be worth if exercised right now. A call has intrinsic value when the underlying is above the strike (underlying − strike). A put has intrinsic value when the underlying is below the strike (strike − underlying). Otherwise intrinsic value is zero.

Time value

Whatever premium is left after intrinsic value is time value: the price of the chance that the option becomes more valuable before expiry. Time value is larger when expiry is further away and when the market expects bigger moves (higher volatility). It shrinks every day and reaches zero at expiry.

Moneyness

• ITM (in the money): the option has intrinsic value. A 24,800 call is ITM when NIFTY is 25,000.
• ATM (at the money): the strike is at or very near the underlying price. ATM options carry the most time value.
• OTM (out of the money): no intrinsic value; the premium is all time value. An OTM option is cheaper but needs a bigger move to pay off.

Example: NIFTY is at 25,000. A 24,900 call trades at ₹160. Intrinsic value = 25,000 − 24,900 = 100. Time value = 160 − 100 = ₹60. If nothing else changes, those ₹60 melt away by expiry.

Caution. Cheap OTM options are tempting, but most of them expire worthless. A low price reflects a low probability, not a bargain.