Part 7 Trading Master Class

Option Premium: What Determines the Price

The premium is what you pay (or receive) to enter an option contract. It is determined by several factors:

Intrinsic Value: The difference between the stock price and strike price, if favorable to the holder.

Time Value: The longer the time until expiration, the higher the premium — because there’s more opportunity for the stock to move.

Volatility: When a stock is more volatile, its options become costlier due to the higher probability of large price movements.

Interest Rates and Dividends: These also slightly affect option prices.

An option pricing model like Black-Scholes or Binomial helps estimate the fair premium based on these factors.