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Why Deeply In-the-Money Options Can Have Little Extrinsic Value

Article Quant Q&A · Author: Coolio2654
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Summary

The note offers a probability-based intuition for why options far from the strike can have little time or extrinsic value, including calls that are deeply in the money. It frames time value around the chance that the underlying crosses the strike before expiration, whether that crossing starts from above or below.

This explanation shifts attention away from the probability that an option stays in the money. The brief answer does not derive an option-pricing formula, quantify crossing probabilities, or account for factors such as volatility, rates, and dividends. It is therefore a concise intuition rather than a complete valuation method, and should not be treated as a standalone pricing rule.

Key ideas

  • Time value is associated with the chance of crossing the strike before expiration.
  • The chance of a strike crossing matters for options that begin either in or out of the money.
  • A high probability of remaining in the money does not by itself imply high extrinsic value.
  • The explanation is intuitive and does not quantify probabilities or provide a full pricing model.

Tags

OptionsDerivatives pricingVolatility
Full text
# Intuitive explanation of why ITM options have low Time/Extrinsic Values?


# Intuitive explanation of why ITM options have low Time/Extrinsic Values?












While brushing up on my knowledge about the Greeks, I have been struggling coming up with an intuitive, probability-based explanation behind why not only Out-of-the-Money (OTM), but also In-the-Money (ITM) options have low Time/Extrinsic values.

For deeply OTM calls (for example), I can see why the Time Value would be low, because there is an extremely low probability of the underlying's price moving so much as to make the call ITM again. However, this is where my present intuition clearly fails, because when a call is deeply ITM, wouldn't it's Time Value actually be high, since the probability of its underlying's price staying within the ITM zone is high?

I feel like this stack post was getting at the answer, but didn't fully elaborate it.

Would someone be able to explain why OTM + ITM options have low Time Values, or at least discern which facets of basic option pricing I am not grasping?

Thank you in advance.

## Answer by dm63 (score 3)

https://quant.stackexchange.com/a/49027

In one sentence, time value has to do with the probability of crossing the strike before expiration (whether from below or above). Doesn’t matter whether the crossing results in the option being in the money or not.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

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