Intrinsic & Extrinsic Value
Intrinsic & Extrinsic Value are what make up an option's premium.
Intrinsic value is what's left at expiration. Out of the money options have zero intrinsic value at expiration. In the money options have an intrinsic value that is equal to the difference between the stock price and the strike price.
Extrinsic value, also referred to as "time value", is made up of time value & volatility. The more days until expiration an option has, the more extrinsic value it will hold. Additionally, the higher the volatility is in the underlying, the more expensive the option will be.
The simple calculation for option pricing is as follows:
Intrinsic Value + Extrinsic Value = Option Price
You can use basic algebra to solve for any of these variables.
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