SIE Ready🎯 Options · Lesson 2 of 6 · 5 min
What a Premium Is Made Of
💲 Two calls on the same stock can trade at very different prices. The difference comes down to two ingredients: intrinsic value and time value.
💡 Key idea
Calls are in the money above the strike, puts below it. Intrinsic value is never negative; whatever premium is left over is time value.
🧠 Why it matters
PREMIUM = INTRINSIC VALUE + TIME VALUE. Intrinsic value is the amount an option is IN THE MONEY, never below zero. A CALL is in the money when the market price is ABOVE the strike; a PUT is in the money when the market price is BELOW the strike. When market price equals strike, the option is AT THE MONEY. An out-of-the-money option has zero intrinsic value, so its whole premium is time value. Time value shrinks as expiration nears. Example: stock at 62, 60 call trading at 5. Intrinsic = 62 − 60 = 2, so time value = 5 − 2 = 3. The 60 put has zero intrinsic value because 62 is above 60.
📈 In the real world
⏳ Leo, a new rep in training, sees a put with a 40 strike trading at 1.50 while the stock sits at 43. He asks why anyone pays for a put that is out of the money. His mentor explains that the whole 1.50 is time value: buyers are paying for the chance the stock drops below 40 before expiration.
📌 Takeaways
- Premium = intrinsic value + time value
- Call ITM: market above strike. Put ITM: market below strike
- Out-of-the-money and at-the-money options have zero intrinsic value
📖 Terms in this lesson
Strike price: The price at which an option holder may buy (call) or sell (put) the underlying.
Premium: The price paid for an option, made up of intrinsic value plus time value.
Intrinsic value: The amount by which an option is in the money; never less than zero.
In the money: A call whose stock price is above the strike, or a put whose stock price is below the strike.
Time value: The part of an option's premium above its intrinsic value, which shrinks to zero by expiration.
CALL UP, PUT DOWN (in the money): A call is in the money when the stock is up above the strike; a put is in the money when the stock is down below it.
✅ Test yourself
A stock trades at 47. Which option is in the money?
- A 45 put
- A 47 call
- A 50 call
- A 50 put
Answer: D · A 50 put
A put is in the money when the market is below the strike: 47 is below 50, so the 50 put has 3 points of intrinsic value. The 50 call and 45 put are out of the money, and the 47 call is at the money.
Stock at 33; a 30 call trades at 4.50. What is the call's time value?
- 7.50
- 1.50
- 3.00
- 4.50
Answer: B · 1.50
Intrinsic value = 33 − 30 = 3. Time value = premium − intrinsic = 4.50 − 3 = 1.50. 3.00 is the intrinsic value, not the time value.
What is the intrinsic value of an out-of-the-money option?
- The strike price
- Its full premium
- A negative number
- Zero
Answer: D · Zero
Intrinsic value cannot be negative. An out-of-the-money option has zero intrinsic value; its entire premium is time value.
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