If you had one extra hour in the day, what would you do?

At first glance, the term Time Value might not seem all that meaningful, but the idea behind is actually quite simple.Time Value is the portion of an option’s price that reflects the possibility that the option’s value could change before it expires. It’s the difference between the option’s market price and its intrinsic value, and it exists because there’s still time for the underlying asset’s price to move. How Does Time Value Work and How Is It Calculated?Time Value plays an important role when it comes to options. An option is a contract that gives you the right (but not the obligation) to buy or sell a stock or another security at a set price in the future.These contracts already have a value today, even if they only become active later. One part of that value is the Time Value. It shows how much the option is worth right now because there’s still time left. During that time, things like the stock price can still change.Another part of the option’s price is the intrinsic value. That tells you how much profit you’d make if you used the option immediately. If there’s no profit today, the intrinsic value is zero. In that case, the entire price of the option comes from the Time Value.The Time Value can be calculated as follows:Time Value shows you how much you're currently paying for the “possible future” – in other words, for the chance that the price will still change and you might make a profit later on. The less time there is until the option expires, the smaller that chance becomes. That’s why the Time Value gets smaller over time. This is called Time Decay. Example on How to Calculate the Time Value:Let’s say you have an option that lets you buy a stock for 100 € in three months. Today, the stock price is 95 €. That means you wouldn’t make a profit right now. In fact, you could buy the stock cheaper on the market than through the option. So you wouldn’t exercise the option today. The intrinsic value is zero.Still, the option costs, for example, 5 €. Why? Because in the next three months, the stock price might go up – maybe to 110 € or even more. Then the option would become profitable, since you’d still have the right to buy the stock for 100 €. That possibility is what you’re paying for. These 5 € are the Time Value.The closer the option gets to its expiration date, the smaller the chance of such price moves – and the smaller the Time Value becomes, until it eventually disappears completely if the option isn’t used. Why Is It Important to Understand Time Value?Now you know what Time Value is, how to calculate it, and why it can be useful in general.If you understand Time Value, it can help you make smarter decisions when dealing with options and other financial products. You’ll be better able to judge whether a purchase is worth it and whether the price is fair.Let's take a look at three key advantages of knowing how to calculate Time Value:You understand how an option’s price is built – what part is based on its current value and what part comes from the potential future.You can better decide whether buying an option is worth it or if it’s too expensive for what it actually offers.You see how much you’re paying for time and opportunity, and you can judge whether the risk is right for you or not. Typical Finance Interview Questions About Time Value (And How to Answer Them)Interviewers at investment banks or other companies in the finance industry often want to make sure you understand key financial concepts and Time Value is definitely one of them.So, let's take a closer look at three common questions you might get, along with ideas on how to answer them:What’s the difference between Intrinsic Value and Time Value in an option?The Intrinsic Value shows the profit you’d make if you exercised the option right now.The Time Value is the part of the option’s price you pay for the time left, because the stock price might still move in your favor before the option expires.Why does the Time Value of an option go down over time?Because with each passing day, there’s less time for the stock price to change. Less time means fewer chances to make a profit, so the Time Value shrinks.Can an option have time Value Even if it has no Intrinsic Value?Yes, it can. For example, if a call option lets you buy a stock for 100 €, but the stock is only worth 95 € today. You wouldn’t exercise it now, so the intrinsic value is zero. But the price might still go up, and you’re paying for that possibility. That’s the Time Value.👉 You can practice these and many more question sets in our Case Library– feel free to check it out!

Ace your inteview at Citigroup with this guide!