Intrinsic value

An option's premium splits into exactly two parts. Intrinsic value is the amount that could be realised by exercising immediately, which is the underlying price less the strike for a call, the strike less the underlying price for a put, and zero whenever that subtraction is negative. Time value, sometimes called extrinsic value, is everything else in the premium: what the market charges for the possibility that the price moves further before expiry.

The two behave differently. Intrinsic value moves point for point with the underlying once the option is in the money and is arithmetic rather than opinion, so two people pricing it get the same answer. Time value is opinion, rises with implied volatility and with the time remaining, and decays toward zero as expiry approaches, faster in the final weeks. At expiry an option is worth its intrinsic value and nothing more, which is why the split is worth keeping separate in the first place.

The word carries a second and unrelated meaning that causes real confusion. In equity analysis intrinsic value is an estimate of what a business is worth, usually the present value of the cash it is expected to produce, and that figure is an opinion built on assumptions that different analysts do not share. The option sense is a definition and cannot be argued with. The analysis sense is an argument, and the two are not related beyond the word.