Intrinsic Value and Time Value

An option's price splits into two parts. Intrinsic value is the advantage the contract already carries — the difference between the strike and the market rate, when that difference favours the holder, and nothing at all when it does not. Time value is the rest of the premium: what the market charges for the possibility that the rate moves further in the holder's favour before the contract expires. The split explains most of what an option's price does over its life. Time value erodes as expiry approaches, and for a contract near the money that erosion is fastest in the final stretch, because less time remains in which anything can happen. It also expands when the market expects more movement and contracts when it expects less, independently of where the rate is. Intrinsic value, by contrast, tracks the market rate directly and nothing else. Neither part is a prediction. They are a decomposition of a price two parties agreed, computed with the quoting market's own conventions rather than a universal formula, which is why figures from two sources are not automatically the same thing.