How Option Time Value Changes as Expiration Approaches

Summary

The document explains why an in-the-money option does not necessarily become more valuable simply because expiration is closer. It separates an option’s value into intrinsic value, determined by the current underlying price and strike, and time value, which reflects the potential for favorable price movement before maturity.

If the underlying price is held constant, intrinsic value remains the same as time passes. The remaining opportunity for price movement shrinks as expiration approaches, reducing time value. Thus, an option can lose value through time decay even when it is in the money and increasingly likely to finish that way. The explanation is conceptual and assumes the underlying price stays unchanged; it does not address how changes in price, volatility, rates, or dividends affect the option’s total value.

Key ideas

• Option value includes intrinsic value and time value.
• Intrinsic value stays constant as expiration approaches if the underlying price does not change.
• Time value declines as the remaining period for favorable price movement shrinks.
• An in-the-money option can lose value from time decay despite a higher chance of expiring in the money.

Tags

# Why doesn't the value of an in-the-money option increase approaching expiration?


# Why doesn't the value of an in-the-money option increase approaching expiration?












I know it is a pretty basic question and I can get this result with BS, however I don't understand it conceptually.

As the time approaches maturity, it is less likely to end out of the money, so I would say that the option value should be higher (positive theta), as it is almost sure that you will exercise it. Could you help me with what I'm missing here?

Many thanks!

## Answer by Alper (score 3)

https://quant.stackexchange.com/a/68262

The value of an option is based on its intrinsic value plus its time value. Intrinsic value is simply based on, for example for a plain option, the strike price of the option and the underlying instrument’s spot price. Intrinsic value remains unchanged as the maturity is approached as long as the underlying instrument’s price remains unchanged. Time value, however, comes from the potential volatility range of the underlying instrument’s price in the period up to the maturity. As the maturity is approached, time value is decreased because the potential volatility range is reduced and therefore the value of the option.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.