Time value definition

What is time value?

Time value is a term used in options trading to refer to the portion of an option’s premium that is attributable to the amount of time left until the option expires. An investor will pay more for an option with a longer time until expiry, because this increases the time available for an option to expire in the money.

When trading options, the premium is determined by the option’s time value, plus its intrinsic value. An option will not have an intrinsic value until the underlying price has exceeded the strike price. If an option is out of the money and the expiry date is approaching, the option is likely to never have an intrinsic value.

Time value example

You can calculate time value by subtracting an option’s intrinsic value from the total premium. For example, if it was mid-July, you might purchase a July 50 option – which is an option with a strike price of 50 that expires at the end of the month. If this had a premium of £40, it would have a time value of £10.

What is the significance of time value for traders?

Time value is significant as most traders will be willing to pay more for an option with a greater time value. This is because there is more time for the option to become in the money, rather than expiring worthless.

Time value vs time decay: what’s the difference?

Time value and time decay are similar terms, but they mean very different things. While time value is the amount of an option’s premium that is attributable to the option’s time until expiry, time decay measures the reduction of an option’s value as it approaches its expiry date. The closer an option gets to its expiry date while being out of the money, the greater the effects of time decay – because the likelihood that an out-of-the-money option will expire increases.