Intrinsic vs Extrinsic Value

Breaking Down an Option's Price

An option's premium can be decomposed into two components: intrinsic value and extrinsic value (also called time value). Understanding this breakdown helps you evaluate whether an option is cheap or expensive and is the foundation for every pricing decision in the wheel strategy.

Intrinsic Value

Intrinsic value is the amount by which an option is in-the-money. It represents the real, tangible value if the option were exercised right now. Out-of-the-money and at-the-money options have zero intrinsic value.

Extrinsic Value (Time Value)

Extrinsic value is everything in the premium above intrinsic value. It reflects the possibility that the option could gain more intrinsic value before expiration. Extrinsic value is driven primarily by time remaining and implied volatility. As expiration approaches, extrinsic value decays to zero -- this is the time decay that wheel sellers profit from.