6. What is an option’s intrinsic value and extrinsic value?
An option value is composed of intrinsice value and extrinsic value.
$Option Value = Intrinsic Value + Extrinsic Value$
The intrinsic value of both call and put options is the difference between the underlying stock's price and the strike price. In the case of both call and put options, if the calculated value is negative, the intrinsic value is zero. In other words, intrinsic value only measures the profit as determined by the difference between the option's strike price and market price.
Intrinsic_Value
Call
Put
Current_Price >= Strike_Price
Current_Price - Strike_Price
0
Current_Price < Strike_Price
0
Strike_Price - Current_Price
Extrinsic value(aka. Time value) measures the difference between the market price of an option, called the premium, and its intrinsic value. Extrinsic value is also the portion of the worth that has been assigned to an option by factors other than the underlying asset's price. The opposite of extrinsic value is intrinsic value, which is the inherent worth of an option. Extrinsic value rises with increase in volatility in the market.
Extrinsic_Value
Call
Put
Current_Price >= Strike_Price
Option_Price- Intrinsic_Value
Option_Price
Current_Price < Strike_Price
Option_Price
Option_Price - Intrinsic_Value