What Is Options Premium?
The options premium is the price you pay to buy an option contract. It's made up of intrinsic value and time value, and is influenced by volatility, time, and distance from strike.
Definition
The options premium is the price per share of an option contract, multiplied by 100 (since each contract covers 100 shares). A $3 premium means you pay $300 to control 100 shares. The premium is paid upfront and is the maximum loss for option buyers.
Premium has two components: intrinsic value (how far in-the-money the option is) and extrinsic value (time value + implied volatility). An option that's $5 in-the-money with $2 of time value has a $7 total premium.
Four factors drive premium: stock price vs strike price, time until expiration, implied volatility, and interest rates. Implied volatility has an outsized effect — during earnings or market uncertainty, premiums spike because more movement is expected.
Real-World Example
MSFT trades at $400. A $410 call expiring in 30 days costs $3 ($300 per contract). This is pure time value (extrinsic) — $0 intrinsic since MSFT is below the strike. If MSFT jumps to $415, the call has $5 of intrinsic value + remaining time value.
Why It Matters
The premium determines your breakeven point and maximum loss. Overpaying for premium (especially into earnings) is one of the most common beginner mistakes in options trading.
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Frequently Asked Questions
Why do premiums spike before earnings?
Implied volatility rises before earnings because the market expects a large price move. Higher expected volatility = higher premium. This is why buying options before earnings (the obvious play) often loses money even when you're right — premiums collapse after the announcement, a phenomenon called 'volatility crush.'
Is a higher premium always better for sellers?
Higher premium means more income upfront, but it also means the market expects more movement. High premium = high risk. The premium fairly compensates sellers for the risk they're taking on.
What does it mean when an option has no intrinsic value?
An out-of-the-money option has zero intrinsic value — its entire premium is time value (extrinsic). This premium decays to zero at expiration if the stock doesn't move past the strike. This is why selling OTM options is a common income strategy.
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