# option time value in the pricing models

option price = intrinsic value + time value where intrinsic value (in other words payoff at N) is defined generally as difference between the underlying asset price and strike price (order depending on the type of the option of course).

In the quantitative pricing models only the difference between the underlying price and strike seem to be modeled. For example the price of a call assuming no arbitrage possible is presented as

$V_{(0)}=\bar{V_n}=E^*[\bar{V_n}]=E^*[\frac{(S_n^j-K)}{S_n^0}]$

how the time value is defined/reflected here?

• I think you are missing an $e^{-rT}$ in front of the expectations operator. – Alex C Jan 20 '16 at 1:15
• $S_n^0$ in the denominator represents the discount – Michal Jan 20 '16 at 1:18
• Time value is reflected in expectation operator. – Neeraj Jan 20 '16 at 6:26
• Time Value is simply "the value that comes from future stock paths that go up", it is captured by taking the expectation in the future, i.e. at maturity. The expectation includes the positive payoff value of those paths (and zero for those paths that go down). – noob2 Jan 20 '16 at 16:47
• so the time value is contained in the expectation together with the intrinsic value but they cannot be directly split, right? it is confusing in relation to such approaches where the premium is divided in time value and intrinsic (Intrinsic value + Time value + Volatility value = Price of Option) nasdaq.com/investing/options-guide/pricing-options.aspx – Michal Jan 21 '16 at 0:10