Option Premium

What Is the Premium of an Option Contract?

An option contract's premium is its market price. At the end of the day, it's how much an option buyer pays an option seller for an option contract.
An option contract is a derivative security that gives the buyer the right to buy (on account of a call option) or sell (on account of a put option) an assortment of underlying securities (generally 100 shares of a stock) at a specific price at the latest the contract's expiration. Think of a premium as the sale price of an options contract.
Options are sold in gatherings of 100 shares, and a premium is paid for every one of those shares, so a contract with a premium of $0.11 would cost the buyer $11 total, or $0.11 times 100 shares. Premiums change continually contingent upon various factors, including the intrinsic value of the underlying asset, the volatility of the underlying asset, and the amount of time staying until the contract's expiration.

What Factors Affect an Option's Premium?

A number of factors meet up to determine the premium (or market price) of an options contract. The three most important are intrinsic value, the volatility or standard deviation of the underlying asset, and the amount of time staying until the contract's expiration.

Intrinsic value

Intrinsic value alludes to the value of an options contract if it somehow happened to be exercised right away (e.g., a call option with a strike price of $60 would have an intrinsic value of $10 on the off chance that the underlying asset was at present trading at $50 in light of the fact that the contract buyer could promptly exercise the contract for a $10 profit).
You can think of an option's intrinsic value as the difference between its strike price and its market price (if profitable to the buyer). On account of a call, an option has intrinsic value in the event that the strike price is below the market price. On account of a put, an option has intrinsic value on the off chance that the strike price is over the market price.
On the off chance that an options contract has intrinsic value, it is thought of "in the money," and its intrinsic value is remembered for its premium. In the event that an options contract doesn't have intrinsic value, it is thought of "out of the money," and its premium depends essentially on its time value and volatility, which together determine how likely the contract is to end up "in the money" when it lapses.

Volatility

Volatility, otherwise called standard deviation, is the degree to which the underlying asset shifts in price consistently. The higher an asset's volatility, the higher its premium, any remaining things considered.

Time value

The time value of an option contract depends on how long remaining parts until the contract lapses. The longer a contract has until expiration, the higher its time value. At the point when a contract is moving toward expiration, brief period stays for the underlying asset to change in value, while when a contract has months until its expiration, the underlying asset has a lot of opportunity to change in value. Different factors to the side, options have higher premiums the farther they are from expiration. It's likewise important to recollect that time value diminishes all the more rapidly the nearer a contract gets to its expiration. All in all, it diminishes dramatically as opposed to directly — this effect is sometimes called "time decay."

Different Factors

The accompanying likewise influence the premium of an options contract however less significantly.

• Dividend rate of the underlying value
• Supply of and demand for the underlying value
• Interest rates
• Market conditions overall

How Is an Option's Premium Calculated?

From an overall perspective, the premium of an option contract is calculated by relegating dollar values to the time until expiration and the underlying asset's volatility and adding these dollar values to the option's intrinsic value. A simple formula, consequently, could look something like this:

Option Premium = Intrinsic Value + Time Value + Volatility Value

Other, less powerful factors (like those listed under "Different Factors" above) may likewise be thought about while ascertaining an option's premium.

Who Pays an Option's Premium and When?

The premium of an option is paid by the buyer to the seller upon the sale of the contract — not at the contract's expiration. Option premiums are not refundable. Options might be sold and resold various times before their expiry, as most traders don't really exercise them. Numerous options traders buy options at one premium with the hope of reselling them for a higher premium later on in view of price changes in the underlying asset.

Is It Better to Exercise an Option or Sell It for Its Premium?

On the off chance that an options contract has increased in value, it typically checks out to sell it for its higher premium than to exercise it and afterward hold or sell the underlying shares. Options have time value, though genuine shares don't, so more gains can generally be realized by selling options for their premium (which incorporates their time value) than by practicing them and selling the subsequent shares at market price (which does exclude a period value).
If, in any case, the underlying asset has a substantial dividend payment coming up, it might check out to exercise the contract to receive the dividend payments guaranteed by ownership of the actual shares. Investors should gauge their options and determine whether practicing or reselling an options contract would bring about additional substantial gains (or more modest losses) on a case-by-case basis.

How Are Option Premiums Taxed?

Whether or not an investor exercises an option contract, the premium of that contract (its price) is viewed as part of their cost basis. At the end of the day, it is deducted from their taxable gains or added to their deductible losses.
On the off chance that an investor possesses an options contract for over one year before it lapses or is resold, any gains or losses they cause are treated as long-term and are taxed as needs be (i.e., at a lower rate than normal income). Alternately, in the event that an investor possesses an options contract for short of what one year before it lapses or is resold, any gains or losses they bring about are treated as short-term and are taxed as needs be (i.e., at a similar rate as the investor's normal income).
More specific and muddled tax situations happen when investors utilize more confounded options-trading strategies like covered calls or protective puts.

Features

• Option premium will comprise of extrinsic, or time value for out-of-the-money contracts and both intrinsic and extrinsic value for in-the-money options.
• The premium on an option is its price in the market.
• An option's premium will generally be greater given additional opportunity to expiration or greater implied volatility.