Option premium
Also called: premium
An option's premium is the price paid to buy it. It is made of intrinsic value (what it would pay if exercised now) plus time value (the chance it becomes worth more before expiry).
Premiums rise with the stock's volatility and with time left to expiry, because both raise the odds of a large move. The seller (writer) of the option keeps the premium in exchange for taking on the risk.
Formula
Premium = intrinsic value + time value
Related terms
- Black-Scholes model: The Black-Scholes model is a formula for the fair price of a European option using five inputs: the stock price, strike, time to expiry, risk-free interest rate and volatility.
- Implied volatility: Implied volatility is the size of future price swings that an option's market price implies.
- Call option: A call option is a contract that gives its buyer the right, but not the obligation, to buy a stock at a set price (the strike) before or at a set date.
- Put option: A put option is a contract that gives its buyer the right to sell a stock at a set price (the strike) before or at a set date.
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