An option's price has two parts: what it would be worth if exercised now, and extra value for the time and volatility left. That second part shrinks to zero by expiry.
12 min read · Level 5
Time value is the quiet reason most bought options lose, and it is rarely emphasised because it does not make for an exciting story. I think anyone buying options should assume that the time value portion of every premium is gone the moment they pay it, and then ask whether the remaining bet is still worth making. Viewed that way, many trades that looked cheap become obviously expensive.
An option premium splits into two parts:
Intrinsic value what the option would be worth if exercised right now Time value everything else: time remaining and expected volatility
With a share at 100:
Option Premium Intrinsic Time value Call, strike 95 7 5 2 Call, strike 100 4 0 4 Call, strike 105 3 0 3
The strike-95 call is already 5 in the money. The strike-105 call has no intrinsic value at all; its whole price is time value.
Time value falls as expiry approaches, and it falls faster near the end. This is time decay. If the share stays at 100, the strike-105 call might, as an illustration, be worth 3 with 60 days left, around 1.9 with 30 days left, and 0 at expiry.
Implied volatility is the level of future price movement that the market's option prices assume. When uncertainty rises - before earnings, during market stress - implied volatility and premiums rise. When the event passes, implied volatility often falls, and premiums can drop even if the share moved the way the buyer expected.
Formal pricing models, such as Black-Scholes and its successors, combine share price, strike, time, interest rates and volatility, but you do not need to calculate them to understand the drivers.
Because an option buyer is fighting time. Every day the share does not move enough, time value leaks away. A correct view that takes too long still loses.
It also explains a common surprise: buying calls before good news, seeing the share rise, and still losing money, because implied volatility collapsed after the announcement and took the time value with it.
And it tells sellers what they are being paid for: bearing the risk of large moves. Premiums are high when the market expects large moves, which is exactly when selling is most dangerous.
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Buying calls before an earnings announcement. A share is at 100. A call with strike 100 costs 6, most of it time value inflated by high implied volatility ahead of results.
Results are good. The share rises to 104. After the announcement, implied volatility drops sharply. The call's new price: intrinsic value 4 plus a little remaining time value, say 1 - a total of 5.
Premium paid 6 Value after results 5 Result -1 per share, or -100 per contract (-16.7%)
The investor predicted the direction correctly and lost 16.7%, because they paid for uncertainty that disappeared once the news was out.
Assuming an option will gain if the share moves the right way. It gains only if the move is large enough and fast enough to outweigh the time value and any fall in implied volatility.
Compute intrinsic value and subtract it from the premium. The rest is time value that will be gone by expiry.
If it is unusually high, for example before an announcement, you are paying extra for uncertainty that may vanish.
Divide the spread by the midpoint price. A bid of 2.80 and ask of 3.20 is a 0.40 spread on 3.00, about 13% - a large cost before anything else happens.
When comparing options with different strikes and expiries, or judging whether a premium is expensive.
Do not treat the illustrative decay path as exact. Actual option prices depend on market conditions and model assumptions.
Options on individual shares typically show higher implied volatility ahead of scheduled announcements such as earnings, followed by a sharp decline once results are released. Options educators and exchange materials describe this pattern widely, and it commonly explains losses by buyers who correctly anticipated the direction of the move.
Before buying options ahead of known news, compare implied volatility to its normal level and assume much of the premium will disappear after the event.
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