This page is the second part of the tutorial on calculating intrinsic and time value of options. In the first part we have covered in the money and out of the money call options. Now we will look at put options. You will find that the logic is the same, only with opposite direction.
In the money put option example
Consider a put option (giving the owner a right to sell) on Bank of America (BAC) stock, expiring in March 2022. Its strike price is 47 and its market price is 4.60 dollars. Bank of America stock is trading at 44.50.
What is the intrinsic value? The idea is the same as with call options, but now when we exercise the put we are selling the underlying, so we want to sell as high as possible. A put option's intrinsic value is the amount by which the put's strike price is higher than the current market price of the underlying stock. The strike is 47 in this case and Bank of America stock is trading at 44.50. Therefore the intrinsic value is 47 less 44.50, equal to 2.50 dollars.
Time value is again what is left from the option's market price after subtracting intrinsic value. 4.60 less 2.50 are 2.10.
Out of the money put option example
In our last example, we now have another Bank of America March 2022 put, this time with the strike price of 42. Its market price is 2.25.
What is the intrinsic value? Strike (42) is below the underlying stock's market price (44.50) and we would not save money by exercising the option. Therefore the option is out of the money and has zero intrinsic value. As a result, the whole market price of the option is equal to the time value (2.25).
Generalization: Same logic for calls and puts
We can summarize all the calculations (for both calls and puts) in only two steps:
- Compare strike price with market price of the underlying stock (get intrinsic value)
- Subtract the intrinsic value from the option's market price (get time value)
Only two things vary. Firstly, there is difference in direction (what you subtract from what when you calculate intrinsic value) between calls and puts. Remember that with calls you are buying the underlying (want low price), while with puts you are selling it (want high price).
Secondly, out of the money options always have the intrinsic value of zero. Therefore at the moment you figure out that an option is out of the money (by comparing strike price and underlying price), you can tell that its time value is equal to its market price.
At the money options
As indicated at the beginning of the first part, for calculating intrinsic and time value, at the money options (the third case of moneyness) work the same as out of the money options.
When an option is exactly at the money, its strike price is equal to the current market price of the underlying. Regardless of being a call or a put, the intrinsic value is always zero in this case.
As a result, the option's time value is equal to its market price, exactly the same as with out of the money options.
Option value per share vs. per contract
Throughout this tutorial we have been using the examples of Bank of America stock. Note that options on individual stocks traded in the US trade in contracts which represent 100 shares of stock. They are however quoted per share.
Therefore, when we said an option's market price was 4.60, in reality you would be buying the option for $460 and its underlying asset would be 100 shares of Bank of America. Similarly, when we calculated a time value of 2.10, the real dollar amount would be $210 for one option contract.