There are two primary components that make up an option's price: Intrinsic Value and Extrinsic Value.

Intrinsic value is otherwise known as the "equity" that you have in the option. For a call option, you take the current price of the stock and subtract the strike price to figure out the intrinsic value. For example, if you have a stock trading at $80.00 and you own a 75 strike call, you have $5.00 worth of intrinsic value. If that 75 call expired today, it would be worth $5.00. Intrinsic value is directly related to the price of the underlying stock. As the price changes, the intrinsic value will change.

Extrinsic value is the part of the option that is a little less clear. It's not based on one thing like price, but several things. These things include time decay, implied volatility, dividends and interest rates. As you can see, extrinsic value is a little more complicated than intrinsic value. That said, as you begin to understand the different components that make up extrinsic value, you will be able to make trades based upon those components. Let's break it down a bit further by looking at the two most important components of extrinsic value: time decay and implied volatility.

Time Decay: This is THE ONLY constant in any option. Time will decay each and every day of the week. If you're going to take advantage of something, take advantage of this as it is the only thing you can count on day in and day out. The Greek associated with time decay is Theta.

Implied Volatility: Implied volatility is the market's best guess, based upon supply and demand, of the future volatility of the underlying stock. Trading implied volatility can be a hard thing to trade on individual stocks. One might be better off trading price and time on individual stocks. However, implied volatility can be traded on index products like the SPY. This is because it's a lot easier to forecast implied volatility on the overall market than it is on individual stocks. As the market goes up, implied volatility goes down. As the market goes down, implied volatility goes up. The Greek associated with implied volatility is Vega. The easiest picture of implied volatility is the VIX, which is the volatility index for the SPX.

On the thinkorswim software platform's Trade Tab, you can choose to see the intrinsic or extrinsic value, and the different Greeks that represent the extrinsic side of the option.

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