Premium is the price paid to purchase an option contract. It represents the cost of buying the right (but not obligation) to buy or sell the underlying asset. Option sellers receive the premium as income. Premium consists of intrinsic value (if any) plus time value. When you buy an option, the premium is your maximum risk.
- Premium = Intrinsic Value + Time Value
- Buyer’s cost, seller’s income
- Maximum loss for buyers is premium paid
How Option Premium Works
Premium has two components:
Option Premium Breakdown:
Premium = Intrinsic Value + Time Value
Example - Call Option:
Stock: $105
Strike: $100
Premium: $8
Intrinsic Value = $105 - $100 = $5 (ITM by $5)
Time Value = $8 - $5 = $3
If stock at $98 (OTM):
Intrinsic Value = $0
Time Value = entire premium
Time value components:
- Time to expiration
- Implied volatility
- Interest rates
Quick Reference: Premium Factors
| Factor | Effect on Premium | Calls | Puts |
|---|---|---|---|
| Stock price rises | Increases | Decreases | |
| Stock price falls | Decreases | Increases | |
| Time passes | Decreases | Decreases | |
| Volatility rises | Increases | Increases | |
| Interest rates rise | Increases | Decreases |
Example: Premium Analysis
Breaking Down a Premium:
| Component | Call ($100 Strike) | Put ($100 Strike) |
|---|---|---|
| Stock Price | $103 | $103 |
| Premium | $6.50 | $4.00 |
| Intrinsic Value | $3.00 | $0.00 |
| Time Value | $3.50 | $4.00 |
Call has intrinsic value; Put is all time value.
Option premium is the price you pay for an option. It consists of intrinsic value (if option is in the money) plus time value. Premium is the maximum a buyer can lose. Sellers collect premium but face larger potential losses.
Factors Affecting Premium
Intrinsic Value
How far ITM the option is. Only ITM options have intrinsic value.
Time to Expiration
More time = higher premium. Theta decay accelerates near expiration.
Implied Volatility
Higher IV = higher premium. Options are expensive before earnings.
Interest Rates
Higher rates slightly increase call premiums, decrease put premiums.
Dividends
Expected dividends decrease call premiums, increase put premiums.
Premium and the Greeks
| Greek | Premium Effect |
|---|---|
| Delta | Premium change per $1 stock move |
| Theta | Premium lost per day |
| Vega | Premium change per 1% IV change |
| Gamma | Rate of delta change |
High vs Low Premium
High Premium Environment
- Before earnings, FDA decisions, etc.
- Favor selling strategies
- Options expensive to buy
Low Premium Environment
- After events resolve
- Low volatility periods
- Options cheaper to buy
Common Mistakes
-
Overpaying in high IV – Premium inflated before events. Often lose even if right on direction.
-
Ignoring time decay – Premium erodes daily. Don’t hold too long.
-
Not comparing premium to stock – 5% premium on a stock needs 5% move just to breakeven.
-
Forgetting premium is per share – Premium × 100 = actual cost per contract.
How JournalPlus Tracks Premiums
JournalPlus logs premium paid and received on all options trades, tracking your average cost basis and helping identify when you overpay or get good value.
