What Is an Option Premium?

An option premium is the current market price of an option contract. It is thus the income received by the seller (writer) of an 澳洲幸运5官方开奖结果体彩网:option contract to another party. In-the-money option premiums are composed of two factors: intrinsic and extrinsic value. Out-of-the-money options premiums consist solely of extrinsic value.

For stock options, the premium is quoted as a dollar amount per shareᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚ𓆏, and most contracts represent the commitment of 100 shares.

Understanding Option Premium

Investors who write, which means to sell in this case, calls or puts use option premiums as a source of current income in line with a broader investment strategy to hedge all or a portion of a portfolio. Option prices quoted on an exchange, such as the 澳洲幸运5官方开奖结果体彩网:Cboe Options Exchange (Cboe), are considered premiums as a rule becaus♓eཧ the options themselves have no underlying value.

The components of an option premium include its 澳洲幸运5官方开奖结果体彩网:intrinsic value, its 澳洲幸运5官方开奖结果体彩网:time value and the 澳洲幸运5官方开奖结果体彩网:implied volatility of the underlying asset. As the option nears its expiration date, the time value will edge closer and closer to $0, while the intrinsic vaꦏlue will closely represent the difference between the underlying security's price and the strike price of the contract.

Factors of Option Premium

The main factors affecting an option's price are the underlying security's price, 澳洲幸运5官方开奖结果体彩网:moneyness, useful life of the 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 decreas🐷es. 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 澳洲幸运5官方开奖结果体彩网:in-the-money, the option's premium normally increases. Conversely, the option premium decreases as the option becomes further 澳洲幸运5官方开奖结果体彩网:out-of-the-money. For example, as an option becomes further out-of-the-money, the option premium loses intrinsic value, and the value stꦕems 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 澳洲幸运5官方开奖结果体彩网:expiration date, the option's premium stems mainly from the intrinsic value. For example, deep out🐬-of-the-money options that are expiring in o༺ne trading day would normally be worth $0, or very close to $0.

Implied Volatility and Option Price

Implied 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 澳洲幸运5官方开奖结果体彩网:long options, an increase in implied volatility would add to the value. This is because the greater the volatility of the un🌃derlying asset, the more chances the option has of finishing i𓆉n-the-money. The opposite is true if implied volatility decreases.

For example, assume an investor is long one call option with an annualized implied volatility of 20%. Therefore, if the implied volatility increases to 50% during the option's life, the call option premium would appreciate in value. An option's vega is its change in premium given a 1% change in implied volatility♈.