The difference between the intrinsic value of an option and its actual value is called the option value. It is called option value because it is the additional value that comes from the option not to exercise if that is a more profitable course.
Option value can be a substantial part of the value of an option. It increases with:
- the volatility of the underlying
- the time till expiry
- the option moving towards being, or further into being, out-of-the-money.
Option value can exist in securities that are not options and in contracts or businesses. It is very important to be aware of these cases, as it is not always obvious that there is option value. It can be tempting to ignore the option value to simplify valuation: this may or may not be sensible depending on how large the option value is likely to be, and whether the data to calculate it exists.