I have been trading options for a few months but still find intrinsic and extrinsic value confusing.
I know intrinsic is the worth if I exercise now, but extrinsic value seems complicated due to time decay and volatility.
I have seen options with high extrinsic value that disappear quickly and lost money not grasping this. I would appreciate a simple explanation of the main differences.
Intrinsic value is clear, extrinsic can change quickly with time decay effects.
Extrinsic value is what you’re paying for the option’s potential to move. When volatility drops or time runs out, that potential disappears fast.
Options lose extrinsic value quickly as expiration gets closer. That’s why short-term options are risky - even if the stock moves your way, you might still lose money.
My AAPL calls suffered from time decay too. I bought them with two weeks left and lost 60% of the premium while the stock did nothing.
Extrinsic value is all about time and volatility. As expiration nears, that value can vanish quickly.
Intrinsic value = current stock price minus strike price for calls. If the option’s out of the money, it’s zero.
Extrinsic value = total premium minus intrinsic value. This decays daily because of theta.
More volatility = higher extrinsic value. Time decay speeds up as you get closer to expiration.
Extrinsic value represents the potential for price movement until expiration. You’re paying for that possibility. As expiration approaches, the likelihood of significant movement decreases, causing the premium to drop quickly. I suggest steering clear of options with fewer than 30 days left unless you anticipate a swift price change. Time decay can severely impact your profits in those last weeks.