Every Premium Splits in Two

The decomposition

Premium = intrinsic value + time value. Intrinsic: what the option is worth if exercised NOW (call: stock − strike, if positive; put: strike − stock). Time value: everything above intrinsic — the price of POSSIBILITY over the remaining life. A $100 call on a $105 stock at $7 premium = $5 intrinsic + $2 time.

The decay law

Time value decays to exactly ZERO at expiration — the option must be worth only its intrinsic value on the last day. Decay accelerates in the final weeks (theta, day 52): an option loses value EVERY DAY its thesis hasn't moved, even if the stock goes nowhere. Option buyers fight a daily tax; premium sellers collect it.

The practical filter

Deep-in-the-money options are mostly intrinsic (little time value — behave almost like stock, less decay drag). At-the-money and out-of-the-money are mostly time value (maximum decay drag, maximum leverage). Buying "cheap" far-OTM options is buying pure time value — the fastest-decaying asset in finance, with the lowest hit rate.

Sources

• Intrinsic vs Time ValueCBOE education
• Option PremiumInvestopedia