What does "time value" signify in options pricing?

Time value in options pricing refers to the potential for an option to gain value before its expiration date. This concept is critical in understanding how options are valued, as it encompasses the idea that there is a period during which various factors—such as changes in the price of the underlying asset, volatility, and time left until expiration—could increase the option's market price.

The time value is influenced by how much time remains until the option expires; more time generally allows for greater potential price movement, thereby increasing the option's value. As the expiration date approaches, this time value diminishes, leading to what's called "time decay." The time value is distinct from intrinsic value, which is based strictly on the option's immediate worth if exercised at that moment, reflecting the difference between the underlying asset's current market price and the strike price of the option.

Understanding the time value is essential for traders and investors when making decisions on options trading and strategies, as it plays a major role in trading profitability and option pricing dynamics.