Intrinsic Value

Safety! Intrinsic value is your friend. It will protect you from losses or, if your stock goes down a lot, reduce your losses.

For out of the money (OTM) options, intrinsic value is zero. There is no intrinsic value if the strike price is above the current stock price.

For in the money (ITM) options, intrinsic value is the current stock price minus the strike. Example: XYZ stock is at $37; a call option with a strike of 35 selling for $5 has intrinsic value of $2/share (37 - 35).

For covered call investors, intrinsic value is part of your downside protection (the other part being time premium). If the stock drops by the amount of the option's price (which is the sum of intrinsic value + time premium) or less then you will not have lost any money.

The lower the strike, the higher the intrinsic value and the more protection you have. In exchange for this protection, the return will be lower (i.e. more intrinsic value = less annualized return). Conservative investors will want to look for options that are at least 10% ITM (the intrinsic value divided by the stock price is > 10%), and possibly as much as 20% ITM (on the Search pages, use the Moneyness slider to find ITM options).

Intrinsic Value Example

Here's an example of intrinsic value. Consider an in-the-money option with a strike of 20 where the option is currently selling for 7 and the stock price is 24. There would be 4 points of instrinsic value: stock price (24) minus strike price (20); and, 3 points of time premium: option price (7) minus intrinsic value (4):

Time premium, intrinsic value, and upside potential relate to each other like this:

For an example showing time premium and intrinsic value graphically, see our blog article Time Premium In Options.

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