More Understanding About Options Time Value
Time value is essentially the cost of risk paid to make available the option buyer the right to buy/sell the stock right up till the day the option ceases. It is exactly like an insurance premium of particular option. More the risk, premium required to purchase an option is high. It is a well-known fact that the value of an option is equal to the total of intrinsic value and time value together.
Keeping other things unchanged, an option’s time value is impacted by both for Call option as well as for Put Options:
* Time remaining until it ceases: The longer the time to expiration, the more time value the option will have and vice versa.
* The proximity of the Strike Price to the money.
At-The-Money options have the highest of time value as it has higher potential for intrinsic value increases the greatest at this point, and the time value decreases considering the movement of options deeper ITM or OTM.
An option will not command a high time value if it is far Out-Of-The-Money as it has got almost no chance of ending-up In-The-Money. Alternatively if an option has deep In-The-Money will have a smaller value as it is more likely that it will certainly get through In-The-Money.
However, options will have a higher time value when they are At-The-Money as they have more uncertainty of finishing In-The-Money.
For both Call and Put options, the time value decreases as expiration is nearing, and it decreases at an increasing rate as it gets nearer to expiration. This happens particularly for At-The-Money (ATM) options. For these options, time value decreases at a faster rate particularly the last one month before expiration.
The price movement of options will be much lesser than price movement of their underlying stock otherwise they are very close to expire. An option’s time value will be lower where stock price is not expected to move much. The opposite holds true where the stocks are highly volatile because uncertainty of prices.
You will see an option losing its value almost by a third of its value in the first half of its life.
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About the author:
Dr. Harsimran Singh was awarded a Ph.D. by a California University for his research work in options trading strategies and he authored 12 books. He traded stock options for 35 years. At times, he traded over a $100 million in a month in his personal account. His research work in options trading has been filed for getting patented with The US Patent Office under Application # 61/999,957.