Options Premium Explained
Options premium is the price you pay for an option contract. It's quoted per share, but since each contract covers 100 shares, the actual cost is the premium multiplied by 100. A $3.00 premium means you pay $300. That's the entire transaction — you pay the premium, and in exchange you receive the right to buy or sell 100 shares at the strike price before expiration.
What Options Premium Is
Premium is both the cost to the buyer and the income to the seller. When you buy a call for $3.00, someone else sold it and received $300. The buyer now has the right to profit if the stock rises above the strike. The seller collected $300 and hopes the option expires worthless so they keep it.
For buyers, the premium is your maximum loss. No matter what happens to the stock, you cannot lose more than what you paid. For sellers, the premium is your maximum profit — you can never make more than what you collected, but you take on the obligation to deliver shares if exercised.
Intrinsic Value vs Extrinsic Value
Every option's premium is made up of two components: intrinsic value and extrinsic value.
Intrinsic value is the real, tangible value of the option right now. For a call option, intrinsic value is the stock price minus the strike price — but only when the stock is above the strike. If AAPL is at $210 and you hold the $200 call, the intrinsic value is $10. If the stock is at or below the strike, intrinsic value is zero. An option with intrinsic value is in the money.
Extrinsic value is everything else — the time remaining until expiration and the implied volatility premium. It's sometimes called time value. An at-the-money call with 30 days left might be worth $5.00 with zero intrinsic value — that entire $5.00 is extrinsic value, representing the possibility that the stock could still move in your favor before expiration.
At expiration, all extrinsic value is gone. Only intrinsic value remains. This is why time decay (theta) constantly erodes the value of options you hold — you're watching the extrinsic value bleed away every day the stock doesn't move enough in your favor.
What Drives the Premium
Stock price vs strike price. The closer the strike is to the current stock price, the more expensive the option. At-the-money options (strike nearest the stock price) carry the most time value. Deep in-the-money options are mostly intrinsic value. Far out-of-the-money options are mostly a lottery ticket — cheap but low probability.
Time to expiration. More time means more premium. A 90-day option costs more than a 30-day option at the same strike because the stock has more time to move. This extra value decays every day — slowly at first, then accelerating in the final 30 days. This is theta decay.
Implied volatility. Higher IV means more expensive options across the entire chain. When traders expect big moves — before earnings, during market uncertainty — they bid up option prices. A stock with 40% IV will have options that cost roughly twice as much as the same stock with 20% IV, all else being equal.
Interest rates. The risk-free interest rate has a small effect on option pricing, captured by the rho Greek. At current rate levels, this is a minor factor compared to the other three.
Why the Same Strike Costs More Before Earnings
This is one of the most important things to understand before trading options around events. Before earnings, implied volatility rises significantly as traders anticipate a large move. That rising IV inflates every option's extrinsic value — the same $200 strike might cost $5.00 in a calm market and $12.00 the day before earnings.
After earnings, the uncertainty resolves. IV collapses back to normal levels — this is the IV crush. The extrinsic value that was inflated before the event evaporates. If you bought a $12.00 call before earnings and the stock rose 3%, your call might only be worth $9.00 afterward — because the $7 in extrinsic value collapsed even as the intrinsic value increased by $3.
This is why traders who buy options before earnings are often right about the direction and still lose money. The premium already priced in the expected move. For the trade to profit, the actual move needs to exceed what the market was already pricing in.
Premium and Your Maximum Risk
For option buyers, the premium defines your risk. You can never lose more than what you paid, regardless of what happens to the stock. A $400 call position risks $400 — not $40,000 worth of shares. This is the core advantage of buying options over buying stock on margin.
For option sellers, the premium defines the maximum gain — but the risk is larger. A covered call seller keeps the premium if the call expires worthless, but the underlying stock can still decline. A naked put seller keeps the premium but faces substantial loss if the stock falls sharply.
See how premium changes at different stock prices and dates in the Options Profit Calculator. The P/L chart shows you exactly what your option is worth at any stock price, today and at expiration.