Option Premium
The option premium is the price of an option: what a buyer pays and a seller collects. Learn what it is made of, how the 100-share multiplier works, and what moves it.
The option premium is the price of an option. It is what a buyer pays to own the contract, and what a seller collects for taking on the obligation. When you see an option quoted at $3, that $3 is the premium.
It is the single most important number on the screen, because it is the money actually changing hands. Let me break down what it is made of and how to read it.
The Sticker Price, Times 100
Options are quoted per share, but one contract always covers 100 shares. So the quoted premium is never the real cost. You multiply by 100.
An option quoted at $3 costs $3 times 100, which is $300 for one contract. A $0.75 option costs $75. A $12 option costs $1,200. This trips up almost everyone at first, so lock it in: the quote is per share, the check you write is per contract.
What the Premium Is Made Of
Every premium is built from two parts, and knowing the split tells you what you are really buying.
Premium = intrinsic value + extrinsic value.
The intrinsic value is the real part, how much the option is already in the money. The extrinsic value is the hope part, what you pay for time and volatility.
Take a $100 call with the stock at $115, priced at $18. Of that premium, $15 is intrinsic (the stock is $15 above the strike) and the remaining $3 is extrinsic (the hope of even more upside before expiration). An out-of-the-money option, with no intrinsic value, is 100% extrinsic value, pure hope.
What Moves the Premium
Five forces push the premium up and down. You control some, the market controls others.
- Stock price moving toward your strike raises the premium
- Time until expiration: more time, higher premium
- Volatility: higher expected movement, higher premium
- Strike choice: options closer to the money cost more
- Interest rates: a small nudge, usually minor (rho)
The first four are the ones worth watching. When someone says an option is "expensive," they usually mean its extrinsic value is fat, driven up by lots of time or high volatility.
- The premium is the price of the option: what the buyer pays and the seller collects.
- It is quoted per share but costs 100 times that per contract.
- Premium = intrinsic value + extrinsic value.
- It moves with stock price, time, volatility, and strike choice.
Pop Quiz
Three quick questions to see what stuck. Pick an answer and the explanation shows up right away.
An option is quoted at $2.50. What does one contract cost?
One contract covers 100 shares, so $2.50 times 100 is $250. The quote is per share; the cost is per contract.
What two parts make up every premium?
Premium is intrinsic value (the real, in-the-money part) plus extrinsic value (the time-and-volatility hope part).
An out-of-the-money option's premium is made of what?
With no intrinsic value, an out-of-the-money option's whole premium is extrinsic, pure hope that decays over time.
Bottom Line
The premium is the price tag on an option, and reading it well means two things: remember to multiply the quote by 100 for the real cost, and know the split between real value and hope value inside it. Do that, and you always know what you are paying for, and whether it is mostly substance or mostly wishful thinking.
Keep going: dig into the two halves with intrinsic value and extrinsic value.