The time value of a put option is I) the difference between the option's price and the value it would have if it were expiring immediately.II) the same as the present value of the option's expected future cash flows.III) the difference between the option's price and its expected future value.IV) different from the usual time value of money concept.

Question

BlackTom AI · Accepted Answer

The question presents four statements about the time value of a put option. 
Option I states that the time value is the difference between the option's price and the value it would have if it were expiring immediately. In option pricing, this is a standard definition: Time value = Option price - Intrinsic value (the value if exercised now). For a put, intrinsic value is max(K - S, 0), and the remaining amount when you subtract that from the market price is the time value. This interpretation aligns with how traders separate premium into intrinsic value and time value.
Option II claims the time value is the same as the present value of the option's expected future cash flows. This is not accurate because the option's price reflects not only expected future cash flows but also the probability-weighted outcomes, volatility, and time to expiration; equating time value to PV of expected cash flows oversimplifies and miscasts what time value represents.
Option III states that the time value is the difference between the option's price and its expected future value. This is imprecise because the “expected future value” framework would conflate several pricing components and doesn’t match the standard decomposition of option price into intrinsic value plus time value. It also ignores the role of time and volatility in generating time value.
Option IV claims the time value is different from the usual time value of money concept. Indeed, the time value of an option captures the premium attached to potential future payoff due to time and volatility, which is a distinct notion from the generic time value of money used in discounting cash flows. They are related ideas but not the same thing, so this statement highlights the conceptual distinction.
In summary, I is a correct description of how time value is defined for an option, II is a mischaracterization that conflates with PV of expected cash flows, III uses an imprecise framing that does not match the standard definition, and IV correctly points out that option time value is not the same as conventional time value of money. Therefore, the statements that align with the conventional understanding are I and IV, while II and III are incorrect.

FINS2624-Portfolio Mgmt - T1 2025

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