What is an option premium?
The premium is the price you pay (as a buyer) or collect (as a seller) for an option contract. It is quoted per share of the underlying stock, but each contract covers 100 shares, so the dollar cost is the quoted price times 100.
If a call is quoted at $2.50, one contract costs $250. If a put is quoted at $0.45, one contract costs $45.
What makes up the premium
Every premium is the sum of two things:
- Intrinsic value: how far the option is already in the money. An out-of-the-money option has zero intrinsic value.
- Extrinsic value (time value): everything else. Driven by time to expiration and implied volatility.
Premium as max loss
For a long call or long put, the premium is also your maximum possible loss on the trade. If the option expires worthless, you lose the full premium. If it finishes in the money, you recover part or all of it, and possibly much more. This defined-risk property is one reason retail traders favor long options over short-selling the stock directly.