Time value is the portion of an option's premium that exists because there is still time for the stock to move. It represents the possibility, not the certainty, of profit. Understanding time value is crucial because it explains why options lose value as expiration approaches, even when the stock price stays the same.
What is Time Value?
An option's total premium consists of two parts:
- Intrinsic value: The real, exercisable value (how much the option is in the money)
- Time value: The extra premium for potential future movement (also called extrinsic value)
Time Value = Option Premium - Intrinsic Value
Key insight: Time value represents hope. Buyers pay for the possibility that the stock will move favorably before expiration. Sellers collect this premium betting it will not happen.
Time Value Example
Consider a stock trading at $105 with a $100 strike call priced at $7.50:
- Intrinsic value: $105 - $100 = $5.00 (the option is $5 in the money)
- Time value: $7.50 - $5.00 = $2.50
The $2.50 time value is the premium paid for the possibility of the stock moving even higher before expiration.
Out-of-the-Money Options
For a $110 strike call when the stock is at $105:
- Intrinsic value: $0 (option is out of the money)
- If the option trades at $1.50, that entire $1.50 is time value
Out-of-the-money options are entirely time value. They have no intrinsic value but still cost money because of the chance they could become profitable.
What Determines Time Value?
Time to Expiration
More time means more opportunity for favorable movement. A 60-day option has more time value than a 30-day option, all else equal. However, time value does not decay linearly - it accelerates as expiration approaches.
Implied Volatility
Higher volatility means larger expected price swings. This increases the probability of a profitable move, so options on volatile stocks have more time value. A 40% IV option will have more time value than a 20% IV option.
Moneyness
At-the-money options have the most time value because they have the highest probability of swinging either direction. Deep in-the-money and far out-of-the-money options have less time value.
Interest Rates
Higher interest rates slightly increase call time value and decrease put time value due to the cost of carrying the underlying position.
Time Value Decay (Theta)
Time value does not disappear at a constant rate. It decays faster as expiration approaches. This is measured by theta, the daily time decay.
Time decay follows a square root relationship:
Time Value is proportional to sqrt(Days to Expiration)
Example of Accelerating Decay
Consider an at-the-money option with 60 days of time value equal to $4.00:
- 60 days: $4.00 time value
- 30 days: approximately $2.83 time value (lost $1.17)
- 15 days: approximately $2.00 time value (lost $0.83)
- 7 days: approximately $1.37 time value (lost $0.63)
- 1 day: approximately $0.52 time value (lost $0.85)
- Expiration: $0 time value
Notice: The option lost $1.17 in the first 30 days but $0.85 in just the final day. This accelerating decay is why many option sellers prefer short-dated options.
Time Value and Trading Strategies
For Option Buyers
Time works against you. Every day that passes without the stock moving significantly, you lose money to time decay. Strategies for buyers:
- Buy options with enough time for your thesis to play out
- Avoid holding through the final weeks unless the trade is working
- Consider the break-even point, which must account for time value paid
- Be aware that you need the stock to move enough to overcome time decay
For Option Sellers
Time works for you. Every day the stock does not move dramatically, you profit from time decay. Strategies for sellers:
- Sell options with 30-45 days to expiration for optimal theta decay
- Sell at-the-money or near-the-money for maximum time value collection
- Understand that higher IV means more premium to collect but also more risk
- Plan to close or roll positions before the final week if profitable
Time Value Formulas
In the Black-Scholes framework, time value is built into the formula. A simplified approximation for at-the-money options:
Time Value (ATM) = 0.4 * S * sigma * sqrt(T)
Where:
- S = stock price
- sigma = implied volatility (annualized)
- T = time to expiration in years
Example Calculation
Stock at $100, IV of 25%, 30 days to expiration:
Time Value = 0.4 * $100 * 0.25 * sqrt(30/365)
Time Value = $10 * sqrt(0.0822)
Time Value = $10 * 0.287 = $2.87
Maximum Time Value: At-the-Money
At-the-money options always have the most time value because:
- They have the highest uncertainty about whether they will be in or out of the money at expiration
- They have the highest gamma, meaning delta changes rapidly
- They offer the most optionality - the right but not obligation has maximum value when the outcome is uncertain
Track Time Decay in Your Trades
Pro Trader Dashboard helps you monitor how time decay affects your options positions and optimize your entry and exit timing.
Time Value vs. Volatility
Time value and implied volatility are closely related:
- When IV increases, time value increases (options become more expensive)
- When IV decreases, time value decreases (options become cheaper)
- After events like earnings, IV typically drops sharply (IV crush), destroying time value
Summary
Time value is the portion of an option's price that exists because of remaining time and volatility. It decays non-linearly, accelerating as expiration approaches. At-the-money options have the most time value, while deep in or out of the money options have less. Understanding time value helps you choose appropriate expiration dates, manage positions, and decide whether to buy or sell options.
Learn more about theta decay or explore extrinsic value.