What is the Difference between Intrinsic and Extrinsic Value?
Forex options' price is calculated in two split components, which are the extrinsic or time value and the intrinsic value.
The intrinsic value of a foreign exchange option is the difference between the rate of the underlying fx spot contract and the strike price, which is known as the American style option or fx forward rate if it is a European style option.
The actual value of the forex option is represented as the option's intrinsic value when exercised. It should be noted that the intrinsic value should be 0 or above 0. If the foreign exchange option has no value at all, then the forex option simply has no intrinsic value - zero value - and never is the intrinsic value represented in negatives.
Time value is what is known as the extrinsic value of the foreign exchange option, which is described as the forex option's value beyond the option's intrinsic worth. Again, it should be noted that for the extrinsic value, the currency option decreases as its expiration date comes near. In other words, a foreign exchange option with 60 days left before expiration date is much more valuable than a foreign exchange option with only 30 days left to go before expiration. The reason behind this the difference in time - more time, more possibility for the fx spot option price to move towards a favorable course. Thus, time is crucially vital, which is why sellers of fx options require a greater amount of premium for the additional amount of time that the buyers are more than happy to oblige.
