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Author: IlanBigfoot Three stars, 500 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 11009  
Subject: Re: Calculating time value? Date: 12/30/2005 7:21 AM
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I'll take a stab at this, just to see if I'm on track with my learning.

Time value is based on time and presumed volitility. As of 12/30/05 there are 49 days left to expiration, 2/17/2006. Time value should begin to shrink dramatically during the last couple of weeks, and will reach zero at expiration.

Feb call $5
Bid 0.8
Ask 1.2
Stock $5.59


Bought @ ask, paid $120 (+commission. maybe, $15. Don't forget!)
intrinsic value $59 (which you could capture minus comm. if you executed the call and sold the stock right away )
By reselling the option @ bid, you could capture $80. So the option is worth more than the stock, so there is a real time value of $21. (80-59) Commissions both ways eat that up.
The stock must rise to $6.20 to break even in 49 days. ($6.50 with commissions or up $.91) To get to $6.20, the stock must rise 10.9%, or 116% annualized. Your belief in whether this will happen depends on fundamentals, technicals, option volitility, etc. This break-even barrier is in essence the time value of the option, what you are giving up for the 49 days.

Say the stock went to $6 tomorrow, or up 7.3%. If this is not very unusual, I wouldn't expect the extra volitility to affect the options, and the time value would shrink slightly as there are now 48 days left (2% of the time left is gone). If this stock has been flat for a long time, everyone might presume the volility to continue and give a lot of time value, especially if the rise is based on big permanent news (new dividend announced, FDA approves a drug, company buy-out rumor that solidifies, etc.) If there is no special news, everyone just realizes the stock is worth $6 instead of $5.59 or the general market went up, time value about same: $21, maybe down to $20. The intrinsic value is now $100, so the bid might rise to 1.2. Or in might not. Even so, notice how the spread and commissions still chew you up.
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