Option Prices Only Have Two Pieces. Once You See Them, Trading Makes Sense.

Added: 2026-05-24

[00:00:00]So, welcome back to Where Do I Start? We are now in episode number six. We have a really nice foundation built. We've talked about call options and put options and option contracts and stocks versus options and a really nice foundation that I think we've set in the first five episodes. In episode number six, right here, we need to tackle one of the most fundamental elements of all of options all over the options market.

[00:00:22]You're going to use this every single day as an active trader. Let's talk about option pricing. And option pricing is actually a fairly complicated concept. Like when you go a few steps down the pathway forward through the forest, like it can get a little hairy pretty quickly. And so, when you start thinking about option pricing models and the Black-Scholes model and partial derivatives and the Greeks and all those kinds of things, it can get absolutely pretty complex. But for what we're going to do right here and right now, we're just going to hit this at a base level and I'm hoping it's going to be fairly straightforward for you. Like again, I recognize you're coming from nothing.

[00:00:56]I'm assuming the only things you know are what we've covered in the first first five episodes. Like I'm assuming you do not come to this with any, you know, knowledge beforehand. And so, all you've learned is what we've kind of gone through in the first first five episodes. So, when I think about option pricing, it's fairly basic. It's very straightforward because there's only two pieces to the puzzle.

[00:01:15]Like the whole puzzle is only two pieces. It's going to be intrinsic value and extrinsic value. Those two things together, they are going to essentially combine to give you the total option price. Like the option price is only those two pieces. And so, one of them is very simple, intrinsic value, which we're going to see in a second. The other one is where things get really complicated and complex when you dig a little further into the understanding of what that means. But at a base level, my hope is that it's not too bad. And not to mention, if you see the option price and you know the intrinsic value because it's pretty simple, you can kind of deductively reason your way to the extrinsic value and just kind of fill in the blank. So, it's a two-piece puzzle.

[00:01:57]It's intrinsic value and extrinsic value. Okay, so let's begin with intrinsic value. So, intrinsic value measures the inherent worth of the option.

[00:02:07]Like, does the option have any built-in value? Does the option have any inherent worth? Now, this statement, this idea, is always from the perspective of the long side of the contract. It doesn't matter if you're talking about a call or you're talking about a put. You're talking about the long call or the long put. So, when you're trying to measure intrinsic value, and you're trying to measure inherent worth, you're always looking at it through the lens of the long side of the contract. So, does this contract give the long side any inherent benefit or inherent worth? And so, when we look at calls and when we look at puts, hopefully, it's fairly straightforward now. If I have a call option, if the stock price is above the strike price, that option is going to have intrinsic value. So, that's a situation where the stock price is 100 and the strike price is 80. So, now if I own that call, if I'm the long call, I can buy the shares at 80 when they're actually worth 100. That clearly has $20 worth of inherent uh inherent value. So, that would have $20 worth of intrinsic value. On the put side, of course, it's going to be kind of the mirror image of that because remember, if I buy a put, it gives me the right to sell stock at the strike price. So, now I want the stock price to be below the strike price. So, let's say that the stock price was 50 and the strike price was 75. And I owned that put. I was a long put holder in that contract. That would be terrific for me because I can sell the shares at 75 when they're only worth 50. So, when I'm thinking about intrinsic value, I'm looking at the inherent worth from the from the perspective of the long side of the contract. And for my call options, I want the stock to be greater than the strike. For my put options, I want the stock to be less than the strike. If the reverse is true, like if I have a call option and the stock is below the strike, or if I have a put option and the stock is above the strike, then the option has no intrinsic value. It has zero intrinsic value. Negative intrinsic value is not a thing. So, the minimum bound on intrinsic value is zero. It's either zero or it's some positive number if it brings the long party an inherent benefit or immediate value. Okay, so that's intrinsic value. Let's now turn our attention to extrinsic value. And extrinsic value is very simple. It's basically everything else. It's It's basically everything else that gets tacked onto the intrinsic value to bring you to the option price. It actually reflects all of the uncertainty between now and whenever that option expires, whether it's 7 days or 14 days or 45 days or what have you. There's obviously uncertainty there, right? There's possibility there. Well, the extrinsic value is going to reflect that uncertainty and that possibility. And one thing to remember, extrinsic values are always positive because clearly between now and expiration, even if it's only a couple of days or even if it's only a couple of hours, if there's some amount of time between now and expiration, that time, that uncertainty, that possibility has to have a price attached to it. Now, of course, if there's not that much time left, if it's only a day or an hour or a couple of days or what have you, the extrinsic value is not going to be very much, right? It's obviously going to be a very small amount. It's going to grow as there's more and more time in the actual cycle. But just understand, extrinsic values are always some positive number.

[00:05:15]With intrinsic value, we learned that's not the case. It depends on whether or not the option brings value to the long side right here and right now. With extrinsic value, that is not the case at all. Now, there are a number of factors that go into impacting extrinsic value.

[00:05:28]There's a handful, but there's really two primary ones that are going to essentially govern the lion's share of how extrinsic values move and they change. It's time and it's volatility.

[00:05:40]And both of these metrics, both of these variables share a positive relationship with the value. Now, later on in this series, we're going to spend specific episodes actually unpacking more around time and more around volatility. But right now, just painting with a very broad brush, it's fairly simple. If there's more time, there's going to be more extrinsic value. And that should That should be fairly I'm hoping obvious and straightforward to you now that we understand what we've gone through in just the last few minutes. If there's more time in the cycle, if I'm looking at 50 days instead of 30 days, or 30 days instead of 10 days, there is the potential for more uncertainty. There is the potential for greater possibilities in that longer window of time. And so, because of that, the extrinsic values must be higher to reflect the greater price of that additional uncertainty.

[00:06:28]So, if time goes up, extrinsic value goes up. If time goes down, extrinsic value goes down. Volatility shares the same relationship that time does with extrinsic value. If there's greater volatility, that's going to mean greater extrinsic values. And you can basically reason this out the same way that we just did with time. If there's greater volatility, that means there's greater uncertainty. If there's greater volatility, that means there's a greater chance for more possibilities to potentially unfold. And so, when volatility goes up, extrinsic values go up. When volatility goes down, extrinsic values go down. So, what I want to do now, let's take a few minutes, like 1 2 maybe 13. Let's hop into the tastytrade platform and let's take a look at a few of these examples in real time and see if we can better understand intrinsic value and extrinsic value. Okay, so here I am in my tastytrade platform and I've got AMD pulled up in the ticker box.

[00:07:19]Let's go into the June cycle with 34 days to go. Now, at this point, I'm hoping you are kind of well aware the puts are on the right, the calls are on the left. And we're going to get into moneyness and out of the money and at the money and in the money in the very next episode in this series. So, I'll unpack those things specifically when we get to that point. But if I'm looking at AMD and I'm looking at the option chain.

[00:07:40]If I grab Let's say I grab the 400 call.

[00:07:44]So, let's say I want to look at this 400 call and we look at the price of the 400 call is around $53. It's obviously moving as the market moves. You've got the bid ask spread differential. We're going to unpack all of that in the future, too. Again, my goal with this series is to move slowly and move at a fairly gradual pace so that hopefully you can grab on to everything as we're kind of trying to lay it down. And so, the price of this AMD 400 call is about $53. Now, look at AMD right now, it's about $433 per share. So, think about that call.

[00:08:19]That call has inherent value to the long side.

[00:08:23]Right? If you owned that call, that would be a good thing because you've got AMD at 433, you can buy it for 400. So, there's a baked-in value there of about $33.

[00:08:35]And so, the differential between that baked-in value of 33, which I'll just put it on the screen right here, just because we can.

[00:08:42]The difference between the 33 of intrinsic value and the option price of about 53 to 54 is going to be the extrinsic value. Now, if you look at the drop-down menus on tastytrade, you can change these variables by just clicking on them. You see I have one of them set to intro to extrinsic value. And so, you can actually have the platform do the math for you. And you see, all right, the inherent worth of the option plus the extrinsic value is going to bring me to the option price. Again, you have a bid price, you have an ask price, and so we still need to understand what those things mean, but we're not quite ready for that just yet. Just understand the price of this option is somewhere between these two numbers. Okay, so that was a call that had intrinsic value.

[00:09:25]Let's look at a call that doesn't have intrinsic value. Like, for example, let's look at this 500 call.

[00:09:31]So, this 500 call is selling for about 13 and 1/2 dollars, give or take. This option, hopefully you can clearly identify now, has no intrinsic value.

[00:09:41]Right? AMD is at 433. The strike price on this call is 500. If you owned this call, you would not use it. Why would you buy AMD at 500 when you can go into the open marketplace and buy it at 433?

[00:09:53]So, right now, this option has no intrinsic value. The intrinsic value is zero, but look at the price. The price is not zero. Why is the price not zero?

[00:10:03]Because again, time has value. Right?

[00:10:07]The possibility, the uncertainty, that has value. And that's going to be reflected in the extrinsic value, which we see over here, is about $13.60.

[00:10:17]Now, that effectively means over the next 34 days, a lot of things can happen in AMD. It could easily go over 500. It could easily become, you know, a situation where the long side of the contract does have inherent worth and immediate value. And so, that is reflected in the extrinsic value, that is also equal to the option price.

[00:10:37]Like my overachievers out there, you may have identified, "Wow, that option price looks eerily close to the extrinsic value." Well, again, remember, the option price only has two pieces, intrinsic value and extrinsic value. So, if the intrinsic value is zero, then that means the entire option price must be extrinsic value. And so, even if you have an option that doesn't have intrinsic value, it's still going to have a price, and that price is going to be 100% extrinsic value.

[00:11:03]And just sticking with AMD since we already have it up on the screen, let's look at the put options. Now, let's say I wanted to look at this 470 put option, still in the June cycle. Stock price is still about the same. Look at the price of this put option. It's about $56 or thereabouts. Now, does this put option give the long side of the contract immediate value? It certainly does.

[00:11:25]Because if I owned this put option, what could I do? I could sell AMD at 470, right? This is the strike of the option, when the stock is really selling for 434. And so that gives me a baked-in value of what looks like about $36.

[00:11:38]And so of this price, $36 of this is intrinsic value. Now again, we can look at our drop-down column here, or we could manually calculate it if we really wanted to torture ourselves. You can look at the extrinsic value over here about $20, that makes sense. $36 of intrinsic plus $20 of extrinsic is going to give me the option price of about 56.

[00:11:59]And then lastly, let's go to some out-of-the-money puts for AMD, but we'll just pick one put to kind of focus on.

[00:12:03]Let's look at this 350 put.

[00:12:06]So this guy is way down below where AMD is now. You can see this put clearly doesn't have any value to the long side of the put contract. Why would he sell AMD at 350 when he would just go into the open marketplace and sell it at 433?

[00:12:18]That doesn't make any sense. But look at the price of the option, it's actually just over $6. Again, no intrinsic value, so I know that is purely extrinsic value, which is confirmed when I look over at this column and I see the extrinsic value is 640. 640 lands between my bid price and my ask price.

[00:12:36]And so those things are lining up. I am seeing option pricing in real time. And so my hope is that looking at this AMD example helps to kind of bring this topic to life. Okay, so those are some option pricing basics. And again, this is one of the most fundamental things that you have to understand as an option trader. You're going to literally use it every single day of your trading career.

[00:12:55]Whether you're buying, whether you're selling, whether you have a profit, whether you have a loss, it's all going to trace back to the option price. It's intrinsic value and it's extrinsic value. Those are the only two pieces of the puzzle, and I hope is now your foundation is getting a little bit more solid as we move further and further along in the series, and I'll see you guys in the next episode.