Intrinsic Value

Intrinsic value is the part of an option's price that comes from the option already being profitable if it were exercised right now, based purely on where the underlying stock is trading versus the option's strike price. It is the "real," built-in value, as opposed to the value attached to time and uncertainty.

For a call option (the right to buy), intrinsic value exists when the stock price is above the strike price. You take the stock price, subtract the strike, and if that number is positive, that's the intrinsic value. For a put option (the right to sell), it works the other way: intrinsic value exists when the stock price is below the strike, and you subtract the stock price from the strike.

If an option has no built-in profit this way — a call with a strike above the current stock price, or a put with a strike below it — its intrinsic value is simply zero. It can never be negative; the worst case is zero, not a negative number, because nobody is forced to exercise an unprofitable option.

The nuance that trips people up is that intrinsic value is only one piece of what you pay for an option. The rest is called extrinsic value (also called time value), which reflects how much time is left until expiration and how volatile the underlying stock is. An option trading at $6 with $5 of intrinsic value only has $1 of extrinsic value — and that extrinsic portion shrinks toward zero as expiration approaches, a process called time decay, even if the stock price doesn't move at all.