Premium
The options premium is the price paid by the buyer to the seller (writer) of an option contract, representing the total market value of one contract covering 100 shares of the underlying stock.
The premium is the price tag of an options contract. Because one U.S. equity option covers 100 shares, you multiply the quoted per-share premium by 100 to find the total dollar cost. A premium quoted at $2.50 therefore costs $250 to purchase one contract. This is the maximum the buyer can lose; the seller receives this amount upfront and keeps it if the option expires worthless.
Premium is composed of two components: intrinsic value and time value. Intrinsic value is the immediate exercise value of the option — how much in the money it currently sits. Time value (also called extrinsic value) reflects everything else: time remaining until expiration, implied volatility, interest rates, and dividends. An out-of-the-money option has zero intrinsic value, so its entire premium is time value.
Several forces push premiums up or down. Rising implied volatility increases premiums because larger expected price swings make it more likely the option will expire in the money. More time to expiration also raises the time-value component — the contract has more opportunity to move into profitability. Higher interest rates modestly increase call premiums and decrease put premiums through the cost-of-carry relationship. Upcoming dividends lower call premiums and raise put premiums, since a dividend payment reduces the stock's price on the ex-dividend date.
Options pricing models — most notably the Black-Scholes-Merton model and the binomial lattice model — attempt to calculate fair value premiums by incorporating these variables. Market-makers use these models as pricing anchors, adjusting quotes in real time as stock prices, volatility estimates, and time change. Retail traders can observe the 'bid-ask spread' around the theoretical value; tighter spreads in liquid markets mean less slippage when entering and exiting positions.
Understanding premium decomposition is critical for risk management. A trader who buys a high-premium contract loaded with time value is betting not just on direction but also on the timing and magnitude of the move. If the stock drifts sideways, time decay steadily erodes the time-value component even without adverse price action.