Extrinsic value

[hissho]

I happened to find this question on another board and am keen to know the answer as well:

just a question about extrinsic value:
1) someone says extrinsic value IS time value; i used to think this is correct until i heard the second statement as follows:
2) extrinsic value is comprised of time value and volatility value and the latter comprises the most of extrinsic value.

ok here are my questions:
1) is statement 2 correct and statement 1 incorrect?
2) if statement 2 is correct, do i NEED TO calculate out of the extrinsic value how much belongs to the "time value component" and how much belongs to the "volatility component"?
3) if the answer to my 2nd question is "yes you need to", then how can i calculate it and then use it?

 

[wayneL]

I happened to find this question on another board and am keen to know the answer as well:

Hi Hissho,

I prefer to "think" in terms of statement 2, but it's really a matter of semantics.

Perhaps think of extrinsic value = risk value. More time = greater risk (to the writer)... also more volatility = greater risk.

So extrinsic value = time and volatolity

 

[stoxclimber]

Agree with wayneL


alternatively one can view it as:

time value - benefit from deferring your payment (i.e. exercise) and assumed risk free return on the asset (if you don't know about this see risk neutral option pricing) - but this bit basically comes from the underyling being expected to grow at a certain rate and you don't have to pay until later (so earn interest benefit)

volatility value - as downside is limited.. this encompasses both volatility over time and time (longer time periods = higher vol, ceteris paribus)

Of course the main driver of value (if seperated this way) is vol .

 

[sails]

I have assumed that extrinsic includes everything that is not intrinsic value - that's been my general understanding rightly or wrongly!

For example - stock trading at $10 - a $9.50 call would have 50c intrinsic and any amount over that would be classed as extrinsic and would include time, volatility, interest rates, etc.

 

[Magdoran]

I have assumed that extrinsic includes everything that is not intrinsic value - that's been my general understanding rightly or wrongly!

For example - stock trading at $10 - a $9.50 call would have 50c intrinsic and any amount over that would be classed as extrinsic and would include time, volatility, interest rates, etc.

I agree with Margaret, this was my understanding too - essentially it is a catch all for anything other than intrinsic value.

Mag

 

[wayneL]

I have assumed that extrinsic includes everything that is not intrinsic value - that's been my general understanding rightly or wrongly!

For example - stock trading at $10 - a $9.50 call would have 50c intrinsic and any amount over that would be classed as extrinsic and would include time, volatility, interest rates, etc.

I agree with Margaret, this was my understanding too - essentially it is a catch all for anything other than intrinsic value.

Mag

I've always preferred the term "extrinsic" value over "time" value for these reasons. It kinda blows away the concept of time value when it is possible for extrinsic value to actually increase as time goes by (for a time anyway)

Also, as an exercise, plug in very low volatility into BSOPM (say 1%) and see what happens to this "time" value. The only value will be cost of carry on calls. Puts will be virtually worthless.

Margaret,

Good to see you back posting.

Cheers