Extrinsic value
Also: time value
What you pay ABOVE intrinsic value: the chance it still improves. It is the only part time destroys.
In the chapter
What you buy and what you commit to
From the same chapter
- CallA contract giving you the RIGHT to buy the underlying at a fixed price before a date. Buying one bets it rises; selling one bets it does not rise that much.
- PutA contract giving you the RIGHT to sell the underlying at a fixed price before a date. It is the most direct way to hedge a fall.
- StrikeThe fixed price at which the contract lets you buy or sell. Choosing it changes the outcome more than getting the direction right.
- ExpirationThe date the contract stops existing. From then on it is worth only its intrinsic value, which is almost always zero.
- Option premiumWhat the contract costs. It is intrinsic value plus extrinsic value, and it is the most a buyer can lose.
- Contract multiplierHow many units of the underlying one contract controls. In stocks it is usually 100, so a premium of 2 costs 200.
- ITMThe strike is already favourable: a call with price above it, a put below. It has intrinsic value.
- ATMThe strike sits right at the current price. It is where the contract holds the most extrinsic value and the most gamma.