What Is the Relationship between an Option’s Premium and Its Extrinsic (Time) Value?
An option's premium is the total price paid by the buyer and consists of two components: intrinsic value and extrinsic value. Extrinsic value, also known as time value, is the portion of the premium that is attributable to the option's remaining time until expiration and the implied volatility of the underlying asset.
The longer the time to expiration and the higher the implied volatility, the greater the extrinsic value. Extrinsic value decays over time, reaching zero at expiration.
Glossar
Time until Expiration
Decay ⎊ Time until Expiration, within cryptocurrency options and financial derivatives, represents the diminishing value of an instrument as its expiration date approaches, a critical factor in theta calculations and overall option pricing models.
Extrinsic Value
Volatility ⎊ This component represents the portion of an option's premium driven by market uncertainty regarding the underlying crypto asset's future price movement.
Intrinsic Value
Valuation ⎊ This represents the in-the-money amount of an option, calculated as the difference between the spot price and the strike price, if positive, otherwise zero.
Implied Volatility
Expectation ⎊ This value represents the market's consensus forecast of future asset price fluctuation, derived by reversing option pricing models using current market premiums.