DATE: November 19, 2012
I have heard that the value of an option has two parts, both "real value" and "time value." But, what do these values mean and how are they calculated?
The "real value" of an option is the amount of money that an option owner would receive if, first, the option was exercised and, second, the resulting stock position was immediately closed. For call options, "real value" is equal to the stock price minus the strike price of the call. For put options, "real value" is equal to the strike price minus the stock price. The "time value" of an option is that portion of an option's total price that is not real value. Specifically, the time value of an option equals the price of the option minus its real value. To learn more about the "real value" and "time value" of an option, view this week's segment of "Ask the Institute."