what is option premium

An option premium is the current market price of an option contract. It is the fee paid by the buyer of an option contract to the seller (writer) of an option contract to get the right to purchase or sell an underlying financial instrument at a predetermined price within a specific period. The premium is also the fee received by the seller in exchange for the obligation to buy or sell an option contract if the option holder decides to exercise the right. The premium has two components: intrinsic and extrinsic value. Intrinsic value is the amount of money investors would get if they exercised the option immediately, and it is equal to the difference between the strike or exercise price and the assets current market value when the difference is positive. Extrinsic value is the time value of the option, which reflects the possibility that the option will increase in value before expiration. The premium will generally be greater given more time to expiration or greater implied volatility. The factors that have a significant effect on options premium include underlying price, strike, time until expiration, implied volatility, dividends, and interest rate.