An option premium is the current market price of an option contract.
All Rights Reserved. Option Premium The price one pays to buy an option contractwhether it is a call or a putwhen one is the first buyer.
It is thus the income received by the seller writer of an option contract to another party. In-the-money option premiums are composed of two factors: intrinsic and extrinsic value.
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Out-of-the-money options' premiums consist solely of extrinsic value. For stock options, the premium is quoted as a dollar amount per share, and most contracts represent the commitment of shares.
Key Takeaways The premium on an option is it's price in the market. Option premium will consist of extrinsic, or time value for out-of-the-money contracts and both intrinsic and extrinsic value for in-the-money options. Option prices quoted on an exchange, such as the Chicago Board Options Exchange CBOEare considered premiums as a rule, because the options themselves have no underlying value.
The components of an option premium include its intrinsic valueits time value and the implied volatility of the underlying asset. Factors of Option Premium The main factors affecting an option's price are the underlying security's price, moneynessuseful life of option premium paid option and implied volatility.
As the price of the underlying security changes, the option premium changes. As the underlying security's price increases, the premium of a call option increases, but the premium of a put option decreases.
Premiums are quoted on a per-share basis because most option contracts represent shares of the underlying stock. Intrinsic value, time value and implied volatility are the three components that determine the price of an option premium.
As the underlying security's price decreases, the premium of a put option increases, and the opposite is true for call options. The moneyness affects the option's premium because it indicates how far away the underlying security price is from the specified strike price.
As an option becomes further in-the-moneythe option's premium normally increases.
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Conversely, the option premium decreases as the option becomes further out-of-the-money. For example, as an option becomes further out-of-the-money, the option premium loses intrinsic value, and the value stems primarily from the time value.
The time until expiration, or the useful life, affects the time value portion of the option's premium. As the option approaches its expiration datethe option's premium stems mainly from the intrinsic value.
Implied Volatility and Option Price Option premium paid volatility is derived from the option's price, which is plugged into an option's pricing model to indicate how volatile a stock's price may be in the future. Moreover, it affects the extrinsic value portion of option premiums. If investors are long optionsan increase in implied volatility would add to the value.
This is because the greater the volatility of the underlying asset, the more chances the option has of finishing in-the-money. The opposite is true if implied volatility decreases. Compare Accounts.