Get started

Option premium

Also known as: options premium, option price

View .mdAsk ChatGPTAsk Claude

An option premium is the price the buyer of an options contract pays the seller. It is quoted per share, so a premium of $2.40 on a standard 100-share equity contract costs $240.

How it works

Every premium breaks into two parts:

  • Intrinsic value: what the option would be worth if exercised right now. For a call, stock price minus strike; for a put, strike minus stock price; never below zero.
  • Extrinsic (time) value: everything above intrinsic value. It reflects the chance the option gains value before expiration and shrinks to zero by expiration day.

Pricing models such as Black-Scholes derive the premium from the stock price, strike, time to expiration, interest rates, expected dividends and implied volatility. Of those, volatility is the input traders argue about most, because it is the only one not directly observable.

Why it matters for traders

The premium is the full risk for a buyer and the maximum reward for a seller. Premiums inflate ahead of known catalysts such as earnings or an FDA decision, because the market prices in a larger move. Once the event passes, the time value can collapse in an IV crush, so a buyer can be right on direction and still lose money. Sellers, by contrast, collect that inflated premium but take on the risk of an outsized move.

Wide bid-ask spreads on the premium are a hidden cost, especially in thinly traded strikes.

Example

Northwind Therapeutics (NWTX) trades at $42. The $40 call expiring in 45 days is quoted at $3.10.

  • Intrinsic value: $42 - $40 = $2.00
  • Time value: $3.10 - $2.00 = $1.10
  • Cost of one contract: $310

If NWTX is still at $42 on expiration day, the call is worth only its $2.00 intrinsic value, and the buyer loses the $1.10 of time value ($110).

FAQ

Who receives the option premium?

The seller (writer) of the option. They keep it whether or not the option is later exercised.

Why is an option premium higher before earnings?

Implied volatility rises before earnings because the market expects a bigger price move, and higher implied volatility means a higher premium.

Track it on Quantisnow

Related terms

Call optionA contract giving the buyer the right, but not the obligation, to buy a stock at a set price on or before a set date.Put optionA contract giving the buyer the right, but not the obligation, to sell a stock at a set price on or before a set date.Implied volatility (IV)The market's forecast of how much a stock will move, expressed as an annualized percentage and backed out of current option prices.ThetaThe estimated amount an option loses in value each day from the passage of time, with all other factors held constant.In the money (ITM)Describes an option with intrinsic value: a call whose strike is below the stock price, or a put whose strike is above it.IV crushThe sharp drop in implied volatility, and in option prices, that typically follows a scheduled event like earnings or an FDA decision.

Part of the Quantisnow financial glossary. For longer explainers, see the investing guides. Educational content, not investment advice.