Option premium

Option premium is the price a buyer pays to purchase an options contract, and correspondingly the amount a seller collects for writing one. It is quoted per share but paid on a per contract basis, and since a standard equity option contract covers 100 shares, a quoted premium of $2 means a total cost of $200 per contract before any commissions or fees.

The premium is made up of two components, intrinsic value and time value. Intrinsic value is the amount the option would be worth if exercised immediately, which is zero for an out of the money option. Time value is everything above that, reflecting the possibility that the option could become more valuable before it expires. Premium is driven by the underlying stock's price relative to the strike price, the time remaining until expiration, implied volatility, interest rates, and any dividends expected before expiration.

For an option buyer, the premium paid is the maximum possible loss on the trade, since the worst outcome is the option expiring worthless. For an option seller, the premium received is the maximum possible profit, and it is collected upfront regardless of what happens later, though the seller can face losses well beyond that premium if the position is not covered or hedged. Understanding what is driving a given premium, mostly time value and implied volatility rather than the stock's current price alone, is central to trading options rather than just buying or selling the underlying stock directly.