The portion of an option’s value that is almost entirely attributed to the time left to maturity. It equals an option’s price (premium) minus its intrinsic value. It represents the portion of the premium that is based on the time remaining until the option expires. And also, it is based in part on the possibility of change in the underlying price during that time. That is, the likelihood that the option would be in the money before or at expiration.
When an option is trading above its intrinsic value, the difference is simply the time value.
Time value = option price – intrinsic value
The more distant the option is from expiration date, the greater the odds it would end up in the money. The empirical evidence suggests that an option loses one-third of its value during the first half of its life and two-thirds during the second half of its life.
Time value is, so to speak, the risk premium paid by the option buyer to the option seller in return for the right to trade (buy or sell) the underlying during the option’s time to maturity.
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