Net Option Premium

What Is Net Option Premium?

The net option premium is the total amount an investor or trader will pay for selling at least one options and simultaneously purchasing others. The combination can incorporate quite a few puts and calls and their separate position in each.

Grasping Net Option Premium

The net option premium can either be positive, which addresses a net cash outflow, or a negative number, which addresses a net cash inflow. The net option premium is helpful in light of the fact that options traders frequently participate in spreads or combination strategies that include at least two options. Since every individual options contract will carry its own premium (for example its market price), the net option premium assists traders with understanding the total outlay or inflow of money for a transaction with various legs.

The net options premium can likewise assist the trader with tweaking the strategy to show up at a specific total premium amount, including a zero-cost position. Knowing the net option premium is likewise vital for working out the maximum loss and the break-even price for a trade including numerous options.

Options spreads include buying one option to sell another. For example, in a long vertical call spread, one call option is purchased at a lower strike price while one at a higher strike price is sold. This diminishes the total net premium as compared with just purchasing the lower-strike call. Spreads, hence, will quite often bring down the net option premium.

Combinations, then again, increase the net option premium. A long straddle, for example, includes purchasing both a call and put at a similar strike price and expiration for the equivalent underlying. The net option premium would in this way be the expansion of the call's and put's individual premia.

Net Option Premium Examples

1. Covered Call: Assume an investor needs to take a synthetic covered call position in a specific stock. In the event that the investor pays $2.50 per part for a put option with a strike price of $55, and afterward sells a call option at a similar strike price for $1 per parcel. The net option premium in this model is $1.50 ($2.50 - $1.00). If, then again, the investor pays $0.50 per part for a put option with a similar strike price, and sells a call option for $1 per parcel, then there will be a net cash inflow (a negative net option premium) of $0.50 ($0.50 - $1.00).
2. Zero-Cost Collar: Sometimes a trader will need to start an options spread for zero cash outlay, or no-cost. Generally these are structured as ratio spreads or as zero-cost collars. For example, if the $55 strike put from the model above is trading at $2.50 and the $50 strike put is trading at $1.25, a trader could buy one of the $55 puts and at the same time sell two of the $50 puts, generating a one-by-two ratio put spread for zero net premium. Of course, as the underlying stock moves or over the long haul, the prices of these options will change diversely and the value of the spread will get away from zero, either in favor or against the trader.

Features

• For options spreads, one option is bought while another is sold, decreasing the net option premium.
• For combinations like straddles and chokes, various options are purchases (or sold) together, expanding the net option premium.
• Net option premium is the total premium (price) connected with an options spread or combination; i.e., including at least two options contracts.