Every option's price is made up of two parts: intrinsic value and extrinsic value. Understanding intrinsic value is essential because it tells you how much real, tangible value your option has right now if you were to exercise it immediately.
What is Intrinsic Value?
Intrinsic value is the amount an option is "in the money." It represents the real, built-in value of an option based on the difference between the stock price and the strike price.
Simple definition: Intrinsic value is what your option would be worth if it expired right now and you exercised it. It is the guaranteed minimum value of an in-the-money option.
How to Calculate Intrinsic Value
The formula is different for calls and puts:
For Call Options
Intrinsic Value = Stock Price - Strike Price (if positive, otherwise 0)
Example: Call Option Intrinsic Value
Stock ABC is trading at $150. You own a call option with a $140 strike.
- Intrinsic Value = $150 - $140 = $10
- This call is $10 in the money
- If you exercised, you could buy shares at $140 and immediately sell at $150
For Put Options
Intrinsic Value = Strike Price - Stock Price (if positive, otherwise 0)
Example: Put Option Intrinsic Value
Stock XYZ is trading at $80. You own a put option with a $95 strike.
- Intrinsic Value = $95 - $80 = $15
- This put is $15 in the money
- If you exercised, you could sell shares at $95 (buy at $80 market price)
Important Rules About Intrinsic Value
Intrinsic Value Cannot Be Negative
If the calculation gives a negative number, the intrinsic value is simply zero. An option can never have negative intrinsic value.
- A call with a $150 strike when the stock is at $140 has $0 intrinsic value (not -$10)
- A put with a $80 strike when the stock is at $90 has $0 intrinsic value (not -$10)
Only In-the-Money Options Have Intrinsic Value
This is a key point:
- ITM (In the Money) options: Have intrinsic value greater than zero
- ATM (At the Money) options: Have zero intrinsic value
- OTM (Out of the Money) options: Have zero intrinsic value
Key insight: Out-of-the-money options have no intrinsic value. Their entire price is extrinsic value (time value). This is why OTM options can go to zero at expiration.
Intrinsic Value vs Option Price
An option's market price is almost always higher than its intrinsic value (except at expiration). The difference is extrinsic value:
Option Price = Intrinsic Value + Extrinsic Value
Example: Breaking Down an Option's Price
Stock is at $100. A $95 call option is trading for $8.50.
- Intrinsic Value = $100 - $95 = $5.00
- Option Price = $8.50
- Extrinsic Value = $8.50 - $5.00 = $3.50
You are paying $5 for the real value and $3.50 for time and volatility.
Why Intrinsic Value Matters
1. Floor Price for Options
Intrinsic value acts as a floor for an option's price. An option should never trade below its intrinsic value because that would create a risk-free profit opportunity (arbitrage).
2. Exercise Decisions
When deciding whether to exercise an option, intrinsic value tells you the immediate benefit. However, you usually should not exercise early because you would give up the remaining extrinsic value.
3. Risk Assessment
Deep in-the-money options have high intrinsic value and behave more like the stock itself. Out-of-the-money options have no intrinsic value and are riskier because they can expire worthless.
4. Understanding What You Are Paying For
When you buy an option, knowing how much is intrinsic vs extrinsic helps you understand what you are really paying for. High extrinsic value means you are paying a lot for time and potential.
Practical Applications
Choosing Strike Prices
- Deep ITM options: Mostly intrinsic value, less affected by time decay, lower percentage gains
- ATM options: No intrinsic value, balanced risk/reward
- OTM options: All extrinsic value, higher risk, higher potential percentage gains
At Expiration
At expiration, all extrinsic value disappears. An option is worth exactly its intrinsic value (if any) or it expires worthless.
Example: At Expiration
You own a $100 call. On expiration day:
- If stock closes at $108: Your call is worth $8 (intrinsic value)
- If stock closes at $100: Your call is worth $0 (no intrinsic value)
- If stock closes at $95: Your call is worth $0 (no intrinsic value)
Track Your Options Performance
Pro Trader Dashboard helps you analyze your options trades and understand which strategies work best for you. Track intrinsic vs extrinsic value changes over time.
Summary
Intrinsic value is the real, immediate value of an option based on how far it is in the money. Call intrinsic value equals stock price minus strike price. Put intrinsic value equals strike price minus stock price. Only in-the-money options have intrinsic value. Understanding intrinsic value helps you make better decisions about which options to trade and what you are paying for.
Next, learn about extrinsic value or read our complete guide on options premium.