Recall that options come in two varieties: Calls and Puts. Both calls and puts can be bought or sold. That's a total of four possible moves, but within those four moves are innumerable possible permutations. For the sake of this very simple explanation, let's focus on what is meant to Time Value and Intrinsic Value.
First, Intrinsic Value. As the term suggests, intrinsic means inherent, built-in, real value. Let's consider a call option on Apple Computer (AAPL). The stock is currently trading at about $350. If you buy a call option at a $320 strike price expiring in May 2011, that means you are buying the right to buy AAPL at $320 on or before May 20, 2011. For that right, you would pay $33.60 on the ask (you buy at the ask and sell at the bid). For 1 contract, the total cost would be $3360. With the stock currently around $350, that means that a full $30 of the cost of the $320 call is intrinsic value, or in the money (ITM). You are therefore buying some "real meat," if you will. You are buying some portion of the stock itself. The remaining cost of the option ($33.60-$30.00=$3.60) is Time Value.
All options, both calls and puts, have what is known as intrinsic value and time value. Time value is that portion of the option that erodes over time. It is much cheaper, dollar-wise, to purchase only time value (out of the money OTM) call options, but the risk is greater. More on that later. In the case of AAPL, as above, by spending $3360, you are actually positioning yourself to profit very closely to the movement of the stock itself; if AAPL rises by $1, your call option is likely to appreciate by a similar amount (called the delta - more later). The delta of ITM call options is significantly higher than deltas for time value call options.
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