The premium is the price of an option, quoted per unit of the underlying. On an Indian index option you pay it per unit and buy whole lots, so a premium of ₹100 on a Nifty lot of 65 costs ₹6,500. Every premium can be split into two parts: intrinsic value and time value.
Intrinsic value
Intrinsic value is what the option would be worth if it expired right now.
- Call: index level minus strike, if positive; otherwise zero.
- Put: strike minus index level, if positive; otherwise zero.
- Only in-the-money options have intrinsic value. At-the-money and out-of-the-money options have none.
Time value
Time value is everything else: premium minus intrinsic value. It is what buyers pay for the chance that the option becomes more valuable before expiry. It depends on:
- Time to expiry: more time, more time value.
- Implied volatility: higher IV, more time value.
- Distance from the strike: time value is largest at the money and shrinks further in or out of the money.
- Interest rates, slightly.
Worked example
Say Nifty is "at 25,000" with 7 days to a weekly expiry and IV at 14%. The model premiums split like this:
| Option | Premium | Intrinsic value | Time value | Time value per lot |
|---|---|---|---|---|
| 24,800 CE | ₹329.55 | ₹200.00 | ₹129.55 | ₹8,421 |
| 25,000 CE | ₹209.21 | ₹0.00 | ₹209.21 | ₹13,599 |
| 25,200 CE | ₹121.26 | ₹0.00 | ₹121.26 | ₹7,882 |
| 25,200 PE | ₹289.86 | ₹200.00 | ₹89.86 | ₹5,841 |
The at-the-money call has the most time value, even though the in-the-money call has the higher premium. The out-of-the-money call is entirely time value.
About these numbers
All numbers here are illustrative: Nifty "at 25,000", implied volatility 14%, interest rate 6.5%, computed with the Black–Scholes model. They are not current market prices.
What happens by expiry
Time value falls to zero at expiry. What is left is intrinsic value, or nothing. So at expiry:
- If Nifty settles at 25,000, the 24,800 CE is worth ₹200 (intrinsic), the 25,000 CE and 25,200 CE are worth nothing.
- A buyer of the 24,800 CE at ₹329.55 would then have lost the ₹129.55 of time value per unit, even though the index did not move.
- A buyer only gains at expiry if the intrinsic value exceeds the premium paid plus charges. That level is the break-even: strike plus premium for a call, strike minus premium for a put.
Time value before expiry
Time value does not disappear evenly. With a month to go, the 25,000 call in our example would have a premium of about ₹469.35, all time value, and lose about ₹9.01 a day. With a week to go it is ₹209.21, losing about ₹16.09 a day. Most of the decay happens in the final days, which is why short-dated weekly options look cheap.
Changes in implied volatility also move time value without any change in the index. A rise in IV adds time value to every option on the chain; a fall removes it. Intrinsic value is unaffected by IV.
Who sets the premium
Premiums are set by trading on the exchange, not by a formula. Models such as Black–Scholes describe how a fair premium relates to the index level, time, volatility and rates, and traders use them to compare prices. When the market pays more for an option, the model reads that as a higher implied volatility.
Why the split matters
- Buyers pay for time value and lose it as time passes; they need a move big enough to add intrinsic value.
- Sellers receive time value, which is the most they can earn, and carry the risk of the option gaining intrinsic value.
- STT on exercise is charged on the intrinsic value at settlement, so letting an in-the-money index option expire has a cost to compare against closing it in the market.
Low premium, high odds of zero
An option that is all time value goes to zero at expiry unless the index moves past the strike. That is why most cheap out-of-the-money options expire worthless.
Examples use illustrative values, not current market data. This is general education, not investment advice.