I have been trading for a while now and I feel many people overcomplicate these concepts.
Intrinsic value is what the option is worth right now. Extrinsic value includes time, volatility, and market mood.
I focus mainly on whether I’m buying cheap or expensive time. This helps me avoid overthinking the math.
Does anyone have a simple way to approach this?
Time decay destroyed me early on. I kept buying options with almost no intrinsic value left.
Now I check if there’s actual movement potential instead of just paying for hope. I made this mistake on Apple calls last month and watched $200 disappear in two days.
The math’s easier when you think of it as buying or selling time premium.
Check the implied volatility percentile.
• Above 50% - paying too much for extrinsic value
• Below 30% - premium is cheap
Helps with timing decisions.
Focus on premium versus how much the underlying needs to move. If you need a big move just to break even, you are overpaying for extrinsic value. Don’t get lost in complex calculations; just check if the trade makes sense with realistic price moves. I learned this the hard way after losing money chasing overpriced options that needed extreme movements to profit.
Delta provides insight into an option’s true value. When it’s close to 0.50, the focus is mainly on stock movement rather than just time decay.
Once delta falls below 0.30, it indicates a bet on large price shifts that may not occur. This straightforward guideline has helped avoid costly errors.
Check moneyness first. Deep OTM options mostly consist of time premium.