What is an option's intrinsic value and time value?

• A. Intrinsic value is the immediate exercise value; time value reflects potential future value before expiration and volatility.
• B. Time value is the immediate exercise value.
• C. Intrinsic value equals strike price; time value equals underlying price.
• D. Intrinsic value is always positive; time value is always zero.

Answer: (A)

The main idea is how an option’s price is made up of two parts: intrinsic value and time value. Intrinsic value is the immediate exercise value—what you’d gain by exercising right now. For a call, that’s the amount by which the stock price exceeds the strike (S − K) when S > K, and zero when S ≤ K. For a put, it’s (K − S) when K > S, and zero otherwise.

Time value represents the chance that the option could become more valuable before expiration. It reflects future potential moves in the underlying and how much time is left, plus the role of volatility. More time and higher volatility increase the time value, because there’s a greater probability the option will move into a profitable range before expiration. The total price equals intrinsic value plus time value, and time value eventually goes to zero at expiration.

So the correct statement captures both pieces: intrinsic value as the immediate exercise value, and time value as the additional value from potential future moves before expiration and the volatility of the underlying.