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Extrinsic Value vs Intrinsic Value for Options

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If you're trying to understand what the difference is between extrinsic value and intrinsic value for options, then you are not alone.

Many people consider options to be one of the most complex investment vehicles available in the stock market, and for good reason since there are many factors that influence their valuations.

 

Extrinsic Value and Intrinsic Value Are Components of an Option's Value

For any given option that is available in the stock market, it's value is made up of exactly two components: intrinsic value and extrinsic value.

Here is an equation to show their relationship:

Option Price = Intrinsic Value + Extrinsic Value

This means that intrinsic value and extrinsic value are the core elements of an option's price.

 

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Intrinsic and Extrinsic Value Definitions

The meaning of intrinsic value is as follows:

Intrinsic value is the amount that an option is in the money, which also represents what the option would be worth if it expired at any given moment.

The meaning of extrinsic value is as follows:

Extrinsic value is the difference between an option's current price and its intrinsic value. In other words, if you take the amount that the option is in the money, and subtract it from the option's current price, that is the extrinsic value.

Extrinsic value can be thought of as a premium you pay to be able to control an option.

Many option buyers look to minimize the extrinsic value of options they buy, while many many option sellers look to maximize the extrinsic value of the options they sell.

This video about intrinsic value vs extrinsic value might help improve your understanding:

Intrinsic and Extrinsic Value Equations

The intrinsic value for call options is calculated as follows:

For call options, if the stock price is above the strike price, the intrinsic value is equal to the stock price minus the strike price. Otherwise, the intrinsic value is zero.

The intrinsic value for put options is calculated as follows:

For put options, if the stock price is below the strike price, the intrinsic value is equal to the strike price minus the stock price. Otherwise, the intrinsic value is zero.

 

The extrinsic value for call options is calculated as follows:

For call options, if the stock price is above the strike price, the extrinsic value is equal to the option price minus the difference between the stock price and strike price. Otherwise, the extrinsic value is equal to the option price.

The extrinsic value for put options is calculated as follows:

For put options, if the stock price is below the strike price, the extrinsic value is equal to the option price minus the difference between the srike price and stock price. Otherwise, the extrinsic value is equal to the option price.

 

As an Excel formula, the intrinsic value of a call option would be this:

=if (Stock Price > Strike Price, Stock Price - Strike Price, 0)

As an Excel formula, the intrinsic value of a put option would be this:

=if (Stock Price < Strike Price, Strike Price - Stock Price, 0)

 

As an Excel formula, the extrinsic value of a call option would be this:

=if (Stock Price > Strike Price, Option Price - (Stock Price - Strike Price), 0)
As an Excel formula, the extrinsic value of a put option would be this:

=if (Stock Price < Strike Price, Option Price - (Strike Price - Stock Price), 0)

 

Extrinsic Value vs Intrinsic Value Example

Imagine that you're looking at Apple and considering buying a call option for it.

Imagine Apple stock is selling for $105, and that you are looking at a 100 strike call option for Apple. It doesn't matter which expiration you're considering when it comes to calculating the intrinsic or extrinsic value of an option.

In this case, to get the intrinsic value, we simply take the stock price of $105 and subtract the strike price of $100.

That leaves us with an intrinsic value of $5.

To get the extrinsic value, first we notice that the stock price is higher than the strike price.

Then, as per the equation above, we take the option price ($7) and subtract the difference between the stock price and strike price ($105 - $100 = $5). In other words, we take $7 and subtract $5.

That leaves us with an extrinsic value of $2.

That means if the stock price was $105 at the time of expiration, the value of the option would be $5. At expiration, the only value of the option is its intrinsic value.

That's why the extrinsic value can be thought of as a premium that is paid to have the privilege of controlling an option. By the time the option expires, that value paid for that premium will be gone.

Using that same example, if the strike price of the option were $110, and the price of the option were still $7, then:

  1. The intrinsic value would be zero since the strike price is higher than the stock price.

  2. The extrinsic value would be $7. Since the strike price is higher than the stock price in that example, the extrinsic value is simply equal to the option's value.

 

When is Extrinsic Value and Intrinsic Value at Their Highest?

Options that are either at the money or out of the money have values comprised entirely of extrinsic value since they have no intrinsic value. Only options that are in the money have intrinsic value.

That means that the deeper in the money the option is, the more intrinsic value it has.

Typically, the further from expiration the option is, the higher the extrinsic value will be.

Also, in many cases, the further the strike price is from the current stock price, the lower the extrinsic value will be. And by the same token, the closer the strike price is to the current stock price, the higher the extrinsic value will typically be.

 

Learning More About Intrinsic Value and Extrinsic Value

If you need more help getting up to speed on options and how extrinsic value vs intrinsic value works, take a look at our guide to options trading for beginners.

If you'd rather leave it to the pros but still want good option investment ideas, you can consider signing up for our options alert service.

You can contact us any time if you would like to ask any questions about extrinsic value, intrinsic value, or about options in general.



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