Option premiums explained Option premiums explained When you buy an option, you pay a premium for the right to trade at a set price within a predetermined time.
Learn more about option premiums in this guide. An option premium is the price that traders pay for a put or call options contract.
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The price you pay for this right is called the option premium. How are option premiums calculated?
For call options, intrinsic value is calculated by subtracting the strike price from the underlying price. For put options, the opposite is true — intrinsic value is calculated by subtracting the underlying price from the strike price.
The longer an option has before it expires, the more time the underlying market has to pass the strike price, and vice versa. Continuing our example above, say you were choosing between two call options on ABC stock with the same strike price but different expiries.
You might consider paying more for the option with the longer expiry, as it gives more time for you to exercise the option at profit. Falling time value is known as time decay, a risk that options traders need to manage.
What is an option premium?
As an option nears expiry, time decay means that its value will drop. A more volatile market is more likely to move beyond the strike price, which means volatile markets will often come with higher premiums. Start trading options by opening a live account The Greeks and option premiums The Greeks — namely delta, gamma, theta, vega and rho — are measures of the individual risks associated with trading options.
- The strike price may be set by reference to the spot price market price of the underlying security or commodity on the day an option is taken out, or it may be fixed at a discount or at a premium.
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These units can help you calculate the risk involved with each of the variables that affect option prices. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument.
Intrinsic Value and Time Value
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Consequently any person acting on a premium or option transaction is does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it.
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- Premiums are quoted on a per-share basis because most option contracts represent shares of the underlying stock.
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