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See intrinsic value. All options have two parts that decide their value.
- Intrinsic value is how much you'd make if you exercised the option right now: it's the difference between the strike price and the current price of the underlying stock.
- Time value is the difference between the current price of the option and its intrinsic value.
Time value also refers to the way that options can help you use time to make money and to limit how much you can lose.
Let's say you buy a stock option today. You know the value of the stock today—you can just Google it. But will it go up or down? Will the option make you money? Since a stock option doesn't require you to buy or sell a stock today, you can use time to your advantage. Maybe a company is launching a new product in three days. If you have a stock option, the value of the stock (and your option) might increase or decrease sharply after that. A call option lets you make money if the stock price goes up, but limits the amount you stand to lose if the stock value goes down (you only ever lose as much as you paid for the option). The closer the stock option gets to its expiry date, the lower the time value involved, since it's unlikely the stock price will change much in the eleventh hour.
The idea of time value is an important concept in investing in general. That is, "a dollar today is worth more than a dollar tomorrow" (in a normal world). Why? Because today you can invest that dollar. Even if you only buy a 1% very safe T-Bill, that dollar today will be worth something like 1.00001 dollars tomorrow. Thanks to inflation, though, the money you get tomorrow will actually be worth less.