Extrinsic value, also called time value, is the extra amount paid for an option beyond its intrinsic value. It represents the market's bet that the option could become more profitable before expiration.
Option Premium = Intrinsic Value + Extrinsic Value
Therefore: Extrinsic Value = Option Premium - Intrinsic Value
If a $140 call on a $150 stock costs $12, then:
Time — The more time until expiration, the more the market is willing to pay. There's more chance for the stock to move.
Volatility — The more a stock bounces around, the higher its extrinsic value. A volatile stock is more likely to surprise you in a profitable direction.
Interest Rates — Small effect, but higher interest rates increase call values.
As expiration approaches, extrinsic value disappears. On the last day of trading, an option has almost no extrinsic value, only intrinsic value. This decay is called theta.
Out-of-the-money options have only extrinsic value (and it's all they ever have). They become worthless as expiration approaches unless the stock moves in their favor.
Buyers lose extrinsic value as time passes. Sellers profit from this decay. This is why most profitable option sellers focus on collecting extrinsic value through strategies like covered calls and cash-secured puts.
Related: Intrinsic Value, Time Value, Theta Decay
