Solution: Intrinsic Value Versus Time Value

Exercise: Intrinsic Value Versus Time Value

Solution

The intrinsic value is $(105-100)^+=5$. The time value is $9.20-5=4.20$.

For a non-dividend stock, optionality and financing make the call worth at least its intrinsic value; otherwise buying the underpriced option and exercising or hedging would create an arbitrage-style improvement.

Takeaways

• Intrinsic value is the immediate exercise value.
• Time value is the extra value of future favourable movement.
• A positive time value does not guarantee the trade will be profitable after premium.