When you look at an option's price, you might wonder what makes up that number. One of the most important components is intrinsic value. Understanding intrinsic value is essential for every options trader because it tells you the real, tangible worth of an option contract.
What is Intrinsic Value?
Intrinsic value is the amount of real value an option has right now. It is the profit you would make if you exercised the option immediately and closed the position in the underlying stock. Think of it as the "real" or "built-in" value of an option.
The simple version: Intrinsic value is how much money the option is worth if you exercised it right now. It only exists when an option is in the money.
How to Calculate Intrinsic Value
The calculation is different for call options and put options, but both are straightforward once you understand the concept.
For Call Options
A call option has intrinsic value when the stock price is above the strike price. The formula is:
Intrinsic Value = Stock Price - Strike Price
Example: Call Option Intrinsic Value
Stock XYZ is trading at $55. You own a call option with a $50 strike price.
- Intrinsic Value = $55 - $50 = $5
- This option has $5 of intrinsic value per share
- Since each contract controls 100 shares, that is $500 of intrinsic value
If the stock was trading at $48, the intrinsic value would be $0 (not negative).
For Put Options
A put option has intrinsic value when the stock price is below the strike price. The formula is:
Intrinsic Value = Strike Price - Stock Price
Example: Put Option Intrinsic Value
Stock XYZ is trading at $45. You own a put option with a $50 strike price.
- Intrinsic Value = $50 - $45 = $5
- This option has $5 of intrinsic value per share
- Per contract, that equals $500 of intrinsic value
If the stock was trading at $52, the intrinsic value would be $0.
Intrinsic Value Can Never Be Negative
This is an important rule to remember. Intrinsic value is either positive or zero. It can never be negative. If the calculation results in a negative number, the intrinsic value is simply zero.
Why? Because you would never exercise an option if it would lose you money. You would just let it expire worthless instead.
Intrinsic Value and Moneyness
Intrinsic value is directly related to whether an option is in the money, at the money, or out of the money:
- In the Money (ITM): The option has intrinsic value greater than zero
- At the Money (ATM): The strike price equals the stock price, so intrinsic value is zero
- Out of the Money (OTM): The option has no intrinsic value
Why Intrinsic Value Matters to Traders
Understanding intrinsic value helps you in several ways:
1. Evaluating Option Prices
When you know the intrinsic value, you can figure out how much you are paying for time value (extrinsic value). If an option costs $7 and has $5 of intrinsic value, you are paying $2 for time value.
2. Making Exercise Decisions
If you hold an in-the-money option near expiration, comparing its intrinsic value to its market price helps you decide whether to exercise, sell, or let it expire.
3. Understanding Risk
Options with high intrinsic value have more "real" value that you can lock in. Out-of-the-money options have no intrinsic value and could expire completely worthless.
Intrinsic Value vs. Total Option Price
The total price (premium) of an option consists of two parts:
- Intrinsic Value: The real, tangible value
- Extrinsic Value (Time Value): The premium above intrinsic value
The formula is: Option Premium = Intrinsic Value + Extrinsic Value
Breaking Down an Option Price
Stock ABC trades at $75. A call option with a $70 strike is priced at $8.
- Intrinsic Value = $75 - $70 = $5
- Total Premium = $8
- Extrinsic Value = $8 - $5 = $3
You are paying $5 for real value and $3 for time value and other factors.
What Affects Intrinsic Value
Only two things determine intrinsic value:
- The current stock price: As the stock moves, intrinsic value changes
- The strike price: This is fixed when you buy the option
Notice what does not affect intrinsic value: time until expiration, volatility, interest rates, and dividends. These factors only affect extrinsic value.
Deep In The Money Options
Options that are deep in the money have high intrinsic value and low extrinsic value. Some traders prefer these because:
- They behave more like the underlying stock
- Less money is lost to time decay
- They have higher deltas (move more with the stock)
However, deep ITM options require more capital to purchase.
Common Mistakes to Avoid
- Confusing intrinsic value with profit: Having intrinsic value does not mean you are profitable. You need to subtract what you paid for the option.
- Ignoring time value: Two options can have the same intrinsic value but different total prices due to extrinsic value differences.
- Forgetting about exercise: At expiration, only intrinsic value remains. All extrinsic value disappears.
Track Your Options Portfolio
Pro Trader Dashboard shows you intrinsic and extrinsic value breakdowns for all your options positions. Make smarter decisions with clear data.
Summary
Intrinsic value is the real, tangible worth of an option based on the current stock price relative to the strike price. Call options have intrinsic value when the stock is above the strike. Put options have intrinsic value when the stock is below the strike. Understanding this concept helps you evaluate option prices and make better trading decisions.
Ready to learn more? Check out our guide on extrinsic value or learn about options moneyness.