I have been trading options for a few months. I understand intrinsic value, but extrinsic value confuses me.
Can anyone explain this in simple terms? A basic example would really help.
Think of buying a car that might become a classic. Intrinsic value is what it’s worth today - actual condition, current market price.
Extrinsic value? That’s the extra you pay betting it’ll gain value by a certain date. As that date gets closer, the extra premium shrinks.
Same with options - extrinsic value melts away as expiration approaches, even when the stock price doesn’t budge.
Extrinsic value consists of two components: time premium and volatility premium. Increased volatility raises extrinsic value. Time decay accelerates in the last 30 days before expiration.
Extrinsic value drops fast near expiration. Lost $200 holding too long once.
Options combine intrinsic and extrinsic value. If you buy a call option on a stock at $145 when it’s priced at $150 for $7, the $5 difference is intrinsic value. The additional $2 is the extrinsic value, which reflects how much you are betting on the stock’s potential movement before expiration. Keep in mind that as expiration approaches, the extrinsic value diminishes. I avoid holding options close to expiration unless I’m very confident about market direction.
My biggest mistake was buying Apple calls at $180 strike when the stock was at $175. Paid $3 per contract.
Apple hit $179 before expiration but my options were only worth $1. Lost that $2 to time decay eating up the extrinsic value.
You’re basically paying extra for hope and time. When both run out, your money’s gone too.