Time value v. Intrinsic Value

CFA Level I
#1

Question: During the life of a European option, the amount by which its price is greater than its exercise value is most accurately described as its:

Answer: Time Value

Explanation: Before expiration, an option can have a price greater than its exercise or intrinsic value. This amount by which an option’s price is greater than its exercise value is referred to as its time value

My question: I agree with this explanation in terms of a call option but does this still hold true with a put option? My confusion lies in the fact that an option premium is calculated as option premium = intrinsic value + time value. Can someone please elaborate with a scenario involving a put option and its time value vs. intrinsic value as it relates to the exercise value in this example.

#2

It’s true for any option.

Suppose that you have a put option with a strike price of $30. If the market price of the underlying asset is $25 and the market price of the put option is $8, then $5 is the intrinsic value of the option and $3 is the time value. If the market price of the underlying asset is $35 and the market price of the put option is $2, then $0 is the intrinsic value of the option and $2 is the time value.

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#3

Ok, I think I see where I got confused. There are several terms here (it seems I switched 1 and 3, as well as 2 and 4):

  1. Market price of underlying asset

  2. Strike price of underlying asset

  3. Market price of option

  4. Intrinsic value (same as exercise value?)

  5. Time value

Market price of option = intrinsic value (exercise value) + time value. Is my understanding correct now?

#4

Looks good to me.

#5

what threw me here at first was the term “exercise value” but I can see in the L1 curriculum that exercise value = intrinsic value (I think “intrinsic value” is much more common in usage).

I agree with @S2000magician’s example. I think in practice we use this version most often:

Time value = Price (aka, value) - Intrinsic Value

…Because the the “time value” is hard to find directly, so we SOLVE for it. But the intrinsic value is easy to calculate/observe. I also think the original question is right to leave out “premium” because I think that’s just the special case of the INITIAL price

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