Trading term

What is Option premium?

The premium is the price a buyer pays for an option — its cost. It has two parts: intrinsic value (how far in the money the option is) and time value (the extra worth of the time left before expiry). Sellers collect the premium in exchange for taking on the option's obligation.

The premium is what changes hands when an option is bought or sold, quoted per share (so a $2 premium costs $200 for one 100-share contract). It's set by the market and driven by a handful of forces: how far in or out of the money the option is, how much time remains, and — crucially — how volatile the underlying is expected to be. More time and more expected volatility both mean a higher premium, because both increase the chance the option pays off.

The premium splits neatly into two components. Intrinsic value is the 'real' part — for a $50 call with the stock at $53, that's $3. Time value is everything above intrinsic — the market's price for the possibility that the option gains more before expiry. An out-of-the-money option has zero intrinsic value, so its entire premium is time value, which decays to nothing by expiration. Understanding this split tells you exactly what you're paying for: real value versus hope-with-a-clock.

Premium = intrinsic + time value
OTM$1.00ATM$2.50ITM$4.00intrinsic valuetime valuepremium = intrinsic + time value

An out-of-the-money premium is all time value; at-the-money carries the most time value; in-the-money adds intrinsic value. The time-value portion decays to zero by expiry.

For example

A $50 call trades for a $4 premium while the stock is at $53. Intrinsic value is $3 (the stock is $3 above the strike); the other $1 is time value — the market's price for the remaining chance of further gains. At expiration, that $1 of time value will have decayed to zero.

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Why it matters to you

The premium is the whole cost and risk of a long option, and splitting it into intrinsic and time value tells you what you're actually buying — real, exercisable value versus decaying time. That distinction is the foundation of options pricing: it's why the same directional bet can be cheap or expensive depending on volatility and time, and why option sellers can profit simply from time passing.

⚠ You're often paying mostly for time

Buyers frequently overpay for time value without realising it — especially on out-of-the-money options, whose entire premium is time value that decays to zero. Paying a rich premium when expected volatility is high (so time value is inflated) means the option can lose money even if the stock moves your way, once volatility falls. Know how much of your premium is time value before you buy.

Frequently asked questions

What is an option premium?

The premium is the price paid to buy an option — its cost, quoted per share (so a $2 premium is $200 per 100-share contract). The buyer pays it to the seller in exchange for the option's rights. It's made up of intrinsic value plus time value.

What determines an option's premium?

Mainly three things: how far in or out of the money it is (intrinsic value), how much time remains until expiry (more time, higher premium), and the expected volatility of the underlying (more volatility, higher premium). Interest rates and dividends play smaller roles.

What's the difference between intrinsic value and time value?

Intrinsic value is how far in the money the option is (a $50 call with the stock at $53 has $3 of intrinsic value). Time value is everything above that — the market's price for the chance of further gains before expiry. Time value decays to zero by expiration.

Why is implied volatility important to the premium?

Implied volatility is the market's expectation of how much the underlying will move, and it directly inflates or deflates the time-value portion of the premium. High implied volatility makes options expensive; when it falls, premiums shrink — which can lose money for buyers even if price moves their way.

Related terms

Call optionA call option is a contract giving the buyer the right — but not the obligation — to buy an asset at a fixed 'strike' price before a set expiry date. Call buyers are betting the price will rise; their risk is capped at the premium paid, while the potential profit is open-ended.Cash-secured putA cash-secured put is an options strategy where you sell a put option while setting aside enough cash to buy the stock if you're assigned. You collect the premium as income; in exchange, you agree to buy the stock at the strike if it falls there. It's a way to get paid to buy a stock you want at a lower price.Covered callA covered call is an options strategy where you own 100 shares of a stock and sell a call option against them. You collect the premium as income; in exchange, you cap your upside at the strike. It's a popular way to generate income on shares you're happy to hold or sell.DeltaDelta measures how much an option's price moves for each $1 change in the underlying. A delta of 0.60 means the option gains about $0.60 if the stock rises $1. It ranges from 0 to 1 for calls (0 to −1 for puts) and doubles as a rough probability the option finishes in the money.
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