Time value is basically the cost of risk paid to provide the option buyer the right to buy/sell the stock until the option’s expiration date. It’s like an option insurance premium; the higher the risk, the higher the premium to buy the option. We already discussed that option value is the sum of intrinsic value and time value. Other things constant, the time value of an option is affected by both call and put options:
Time Remaining to Expiration: The longer the time to expiration, the more time value the option will have and vice versa.
The proximity of the strike price to the money.
At-The-Money options have the highest time value, as they have the greatest potential for intrinsic value to increase further at this point, and time value decreases as intrinsic value moves toward higher options. deep in-the-money and deeper out-of-the-money options.
An option will not have a high time value if it is far out of the money, since it has almost no chance of ending up in the money. On the other hand, if an option is deep In-The-Money, it will have a lower value since it is more likely to end In-The-Money. However, options will have a higher time value when they are in the money, since they have more uncertainty of ending up in the money.
For both put and call options, the time value of an option decreases as expiration approaches and decreases at an increasing rate as expiration approaches. This is particularly the case for At-The-Money (ATM) options. For these options, the time value decreases at a faster rate, especially the last month before expiration.
The price movement of the options will be much less than the price movement of its underlying shares, unless they are in-the-money or very close to expiration. The time value of options will be less when the stock price is not expected to move much. The opposite is true for more volatile stocks, mainly due to the uncertainty of the stock price before the option expires. In general, an option loses almost one-third of its value during the first half of its life and two-thirds during the second half of its life.
