What Is the Relationship between Probability and Time Value?
Time value is directly related to the probability of an option expiring In-The-Money (ITM). The higher the uncertainty or the greater the probability of a favorable outcome, the higher the time value.
ATM options have the highest time value due to the maximum uncertainty.
Glossar
Time Value
Component ⎊ Time value, also known as extrinsic value, is a component of an option's premium that reflects the probability of the underlying asset's price moving favorably before the option expires.
Probability
Modeling ⎊ Probability is fundamental to quantitative finance, providing the mathematical framework for modeling asset price movements and calculating risk.
Probability of Moving ITM
Calculation ⎊ The probability of moving ITM is a quantitative metric derived from an options pricing model, such as the Black-Scholes model, which estimates the likelihood that the underlying asset's price will cross the option's strike price before expiration.