Options Premium
Quick Definition
The price paid by the option buyer to the seller for the rights conveyed by the contract, determined by intrinsic value, time value, and volatility.
What Is Options Premium?
The options premium is the market price of an option contract — the amount the buyer pays and the seller receives. Premium is composed of intrinsic value (the amount the option is in the money) and extrinsic value (time value plus volatility premium). Key factors that increase premium include: higher implied volatility, more time to expiration, the option being closer to or in the money, higher interest rates (for calls), and upcoming dividends (for puts). Premium is quoted on a per-share basis but applies to 100 shares per contract, so a premium of $3.50 costs $350 per contract. For option buyers, the premium represents the maximum possible loss. For sellers, the premium received is the maximum possible profit. Premium erodes over time (theta decay) and can change dramatically with shifts in implied volatility.
Options Premium Example
- 1A $100 call trading at $5.50 premium costs $550 per contract (100 shares × $5.50). If $3 is intrinsic value and $2.50 is time value, the $2.50 will decay to zero by expiration
- 2Before earnings, a stock's ATM options have a premium of $8. After the announcement, IV crushes and the premium drops to $4 even though the stock barely moved
Related Terms
Intrinsic & Extrinsic Value
The two components of an option's price: intrinsic value (profit if exercised now) and extrinsic value (time value plus volatility premium).
Implied Volatility (IV)
The market's forecast of the likely magnitude of future price movements, derived from current option prices using pricing models.
Time Decay
The reduction in an option's value as it approaches its expiration date, reflecting the decreasing probability of a profitable move.
Theta (Options)
The Greek that measures the rate at which an option loses value as time passes, also known as time decay.
Options Greeks
A set of risk measures (delta, gamma, theta, vega, rho) that quantify how an option's price responds to changes in various market factors.
Call Option
A contract giving the holder the right, but not the obligation, to buy an underlying asset at a specified price within a specified time period.
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