Intrinsic And Extrinsic Value
Intrinsic and Extrinsic Value
Option contracts are made up of two different types of value which are ‘intrinsic value’ and ‘extrinsic value’.
‘Intrinsic value’ is the option's value that exists from being ‘in-the-money’ - while ‘extrinsic value’ is made up from the option's ‘time value’.
It is possible that option contracts can contain both types of value at the same time, or they might contain just one or the other.
For example, an option contract that is out-of-the-money will be made up entirely of extrinsic or time value.
An option that is deep in-the-money will be made up almost entirely of intrinsic value.
Option contracts can be bought, sold, or combined together in numerous ways to create a variety of different option trading strategies.
These different types of option strategies may be used to hedge existing positions, take a directional stance on an underlying or particular market, or to simply take advantage of the passing of time by selling option contracts / option positions to profit from time decay.
While there are many types of different option trading strategies that can be used, all of them are constructed from just two basic types of options contracts which are known as ‘call options’ and ‘put options’.
