Extrinsic value is the portion of an option’s price that exceeds its intrinsic value. It's often referred to as the option’s time value. This value reflects the probability that the option will gain intrinsic value before expiration.
Key factors influencing extrinsic value include time remaining until expiration, implied volatility, and interest rates. As expiration nears, extrinsic value erodes — this is known as time decay (theta).
For example, if a call option trades for $5 and has $2 of intrinsic value, the remaining $3 is its extrinsic value. At-the-money options typically have the most extrinsic value.