Unit 2 · Level 1 · Pricing intuition
Two kinds of value
Every option price splits cleanly in two. INTRINSIC value is what exercising right now would earn: hard cash, no imagination required. EXTRINSIC value is everything on top, the price of what could still happen before expiry. Stock at €108, €100 call priced at €11? That's €8 of fact and €3 of possibility.
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What you get asked
Intrinsic value is…
Intrinsic value is the no-imagination part: stock price versus strike, today. Everything else in the premium is extrinsic.
The stock trades at €108. A €100-strike call is priced at €11. How much of that price is extrinsic (time) value?
Intrinsic = €108 − €100 = €8. Extrinsic = premium − intrinsic = €11 − €8 = €3. That €3 is what you're paying for possibility.
An out-of-the-money option's premium is 100% ___ value.
Exercising an OTM option earns nothing today, so its entire price is possibility. That's exactly why time is its enemy.
Match each situation to its value mix.
Extrinsic value peaks at the money with lots of time left. Maximum uncertainty means the maximum price of possibility.
Why would anyone pay extrinsic value on top of intrinsic?
Extrinsic value is a fair charge for optionality, and it does NOT convert into anything. Left alone, it simply melts. That melt is our next lesson. 🐜
The rest of this unit
Intrinsic, extrinsic, theta and IV: what a premium is really made of.