I keep hearing about extrinsic value but I do not understand what it means in trading. It was mentioned in some options posts and I think it is important to grasp. I have been trading for a while but this term still confuses me. Could someone explain it in simple terms?
Extrinsic value is the time premium on an option. It includes what you pay for the remaining time until expiration and market volatility.
Each option price comprises intrinsic and extrinsic value. The important part is that extrinsic value declines as expiration approaches, especially in the final weeks.
Increased volatility leads to higher extrinsic value, as larger price movements improve your chances of profiting.
Extrinsic value is the premium you pay for the potential of an option. It accounts for time and volatility. If you hold an option too long, this value decreases as expiration nears, meaning you can lose money even if the stock moves in your favor. Understanding this will help you manage your risks effectively.
Extrinsic value is what you pay above an option’s actual worth. I learned this the hard way early on - bought Amazon calls with barely any time left. Even though the stock went up, my options expired worthless. Lost money because that extrinsic value disappeared fast.
Option price equals intrinsic value plus extrinsic value. Extrinsic value declines to zero at expiration. Subtract intrinsic value from total premium to determine extrinsic value.
Extrinsic value represents the potential for price change. It decreases as expiration nears.