The intrinsic value of an option is the amount that the market price is higher than the strike price for a call and lower than the strike for a put. In other words, the intrinsic value is the amount of money that the option would be worth if it expired today. For the option to have intrinsic value, the option must be in-the-money.
In-the-money and out-of-the-money are often falsely used by beginning traders. Many traders refer to a profitable option trade as being in-the-money. However, this is not the case. An option can be in-the-money and not profitable. Likewise it can be out-of-the-money and be a profitable trade.
Call options are described in the following way (see Figure 1.1):
- In-the-money—The futures price is above the strike price.
- At-the-money—The futures price is at the strike price.
- Out-of-the-money—The futures price is below the strike price.
Figure 1.1 The intrinsic value of a call option
Put options are described in the following way (see Figure 1.2):
- In-the-money—The futures price is below the strike price.
- At-the-money—The futures price equals the strike price.
- Out-of-the-money—The futures price is above the strike price.
Figure 1.2 The intrinsic value of a put option
As shown in the Figure 1.3, the intrinsic value increases tick for tick as the market moves beyond the strike price of the option. In this case, it is a corn call option with a strike price of $2.70. With the market at $2.80 the option has an intrinsic value of 10 cents; with the market at $2.90 the option has an intrinsic value of 20 cents, and so on. It is important to realize that before expiration the option value will not be equal to the intrinsic value because it will also have extrinsic, or time, value.
Figure 1.3 The intrinsic value of a $2.70 corn call with the market at various prices