What is Extrinsic Value?
Extrinsic Value is defined as the difference between an option's market price, or premium, as well as its intrinsic value. It is one portion's worth that has been allocated by the variables apart from the value of the underlying security. This value is the absolute opposite of intrinsic value, which refers to an option's inherent worth.
Understanding Extrinsic Value
The price or premium of an opportunity is the sum total of extrinsic and intrinsic value. When an alternative is in the money, intrinsic value is the difference between the cost of the underlying securities and the strike price of the alternative.
Since the time left until the alternative deal ends is one of the main aspects impacting the option premium, extrinsic value is also known as "time value." In normal conditions, an agreement depreciates as it reaches its expiry date since the underlying security has less opportunity to switch in its favor.
For example, outside of the money option with one month till expiry will get more extrinsic value than an out-of-the-money option including one week until expiration. The risk premium is another factor that determines this value. The proportion underlying security may change over a given period is measured by implied volatility. This value goes up as indicated volatility rises.
Practical Example
If a call option's market rate is $30 and the underlying asset is $33, the option has an intrinsic value of (33-30) $3. The genuine option may be worth $4, hence, the (4-3) $1 difference is extrinsic value.
In Sentences
- Extrinsic value is a financial term that indicates the difference between market price and intrinsic value.
- Extrinsic value can be quite useful to calculate the premium price.