Definition: Time premium describes the part of an option price that is above the intrinsic value of the option. Typically, the more time remaining on an option, the higher its time premium. The reasoning behind this is that the more time you have on an option, the better chance you have for the underlying futures contract to move in your direction.
Option prices are made up of intrinsic value and time premium.
The price of an in the money option consists of its intrinsic value plus any time premium.
The price of an out of the money option consists only of its time premium - there is no intrinsic value.
More volatile markets will normally have higher time premium than less volatile futures or commodities markets.
Also Known As: time value, volatility premium
Examples:
A December gold futures contract is trading at $600 and Mary bought a December $590 gold call option at $15 (contract value of $1,500 - 100 ounces x $15).
The time premium on this option would be $5 ($600 - 590 = $5). The intrinsic value would be $10.
