Which of the following best describes the time value of an At-the-Money (ATM) option?

Question

Which of the following best describes the time value of an At-the-Money (ATM) option?

BlackTom AI · Accepted Answer

Consider the concept being tested: the time value of an option in relation to how far the stock price is from the strike. 
Option 1 states that the time value is at a minimum when the stock price equals the strike. This is a misread of the typical time-value pattern; while intrinsic value is zero at ATM, the time value is not necessarily at a minimum there, and in many cases ATM options actually have the largest time value due to higher probability of finishing in or out of the money by expiration. 
Option 2 asserts that the time value is highest when the option is at-the-money. This aligns with common option theory: at ATM, the probability distribution around expiration is most uncertain, and small moves in the underlying can significantly affect payoff, maximizing the premium attributed to time until expiration. The time value is largest because there is substantial uncertainty about the option’s payoff with little intrinsic value currently contributing, so the premium largely reflects time. 
Option 3 claims the time value is zero because the option is at its intrinsic value. In reality, ATM options have intrinsic value of zero but their total price includes a meaningful time value component, reflecting the chance of becoming in-the-money before expiry. Therefore, this statement is incorrect. 
Option 4 describes time value as the difference between strike and current price, which is essentially the intrinsic value (or absolute deviation) and ignores the time-to-expiration component. Time value is not simply the straight difference between strike and price; it also captures volatility, time remaining, and other factors. This makes the statement inaccurate. 
In sum, the only option that correctly characterizes the time value behavior for ATM options is the one that identifies ATM as having the highest time value due to maximal uncertainty near expiry, with little intrinsic value to contribute. The other options misstate the relationship between price, strike, and time value or confuse intrinsic value with time value.

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Which of the following best describes the time value of an At-the-Money (ATM) option?

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