Which statement describes intrinsic value and time value for options?

• A. Intrinsic value equals max(price − strike, 0) for calls; time value = premium − intrinsic value
• B. Intrinsic value equals strike − price for calls; time value equals premium plus intrinsic value
• C. Intrinsic value is always zero; time value is the entire premium
• D. Intrinsic value equals max(strike − price, 0) for calls; time value equals premium − intrinsic value

Answer: (A)

Intrinsic value is the amount an option would be worth if exercised right now. For a call option, this is the stock price minus the strike, but not less than zero: max(price − strike, 0). The premium you pay for the option consists of this intrinsic value plus time value, which captures the chance the stock price could move further in your favor before expiration. So the time value is the premium minus the intrinsic value.

For example, if the stock is trading at 110 and the strike is 100, the intrinsic value is 10. If the option premium is 12, the time value is 2. The other statements mix up the formulas or omit the fact that intrinsic value can be positive when in the money, or add rather than subtract intrinsic value from the premium.