# Option Premium > The option premium is the price paid for an option. Learn what drives it, including price, strike, time, volatility, rates and dividends, with worked examples. Source: https://learn.tradelabsai.com/options/option-premium/ Track: Options · Level: Intermediate · Updated: 2026-10-03 Publisher: TradeLabs AI (https://tradelabsai.com). Education, not financial advice. Cite as: TradeLabs Learn, "Option Premium", https://learn.tradelabsai.com/options/option-premium/ The premium is the price of an option: what the buyer pays and the seller receives. It is quoted per unit of the underlying, so a US stock option quoted at $2.40 costs $240 for one contract of 100 shares. The premium is not arbitrary. It reflects the value of the right the option gives, which depends on where the underlying is, where the strike is, how much time is left and how much the underlying is expected to move. ## The two parts of the premium ``` premium = intrinsic value + extrinsic value ``` - **Intrinsic value:** what the option would be worth if exercised right now. For a call, the underlying price minus the strike (if positive); for a put, the strike minus the underlying price (if positive). - **Extrinsic value** (time value): everything else, the price of time and uncertainty. See [Intrinsic and Extrinsic Value](https://learn.tradelabsai.com/options/intrinsic-and-extrinsic-value/). **Example: Splitting a premium** A stock trades at $52. A $50 call expiring in 45 days costs $3.80. Intrinsic value is $52 minus $50, or $2.00. Extrinsic value is $3.80 minus $2.00, or $1.80. If the stock is still at $52 on expiration day, the option will be worth only its $2.00 intrinsic value; the $1.80 of time value will have decayed away. ## What drives the premium | Factor | Effect on call premium | Effect on put premium | Greek | |---|---|---|---| | Underlying price rises | Up | Down | [Delta](https://learn.tradelabsai.com/options/delta/) | | Higher strike | Down | Up | | | More time to expiration | Up | Up (usually) | [Theta](https://learn.tradelabsai.com/options/theta/) | | Higher implied volatility | Up | Up | [Vega](https://learn.tradelabsai.com/options/vega/) | | Higher interest rates | Up | Down | [Rho](https://learn.tradelabsai.com/options/rho/) | | Larger expected dividends | Down | Up | | The Greeks measure how much the premium changes when each factor changes. See [The Option Greeks Explained](https://learn.tradelabsai.com/options/the-option-greeks-explained/). ## Volatility: the hidden driver Of all the inputs, only implied volatility cannot be observed directly. It is the market's estimate of how much the underlying will move, backed out from option prices. When traders expect big moves, such as before earnings, implied volatility and premiums rise. After the event, they often fall sharply, which is called volatility crush. See [Implied Volatility (IV)](https://learn.tradelabsai.com/volatility/implied-volatility/) and [Volatility Crush and Expansion](https://learn.tradelabsai.com/volatility/volatility-crush-and-expansion/). **Example: Same option, different volatility** A one month at the money call on a $100 stock might cost about $2.30 with implied volatility at 20%, and about $4.60 at 40%. Using the common approximation that an at the money option is worth about 0.4 × price × volatility × √(time in years), with time = 1/12: 0.4 × 100 × 0.20 × 0.289 ≈ $2.31, and doubling volatility roughly doubles the price. ## Pricing models Option prices are usually calculated with models. The Black Scholes model, published in 1973, gives a formula for European options based on the underlying price, strike, time, volatility and interest rates. Binomial trees handle American options that can be exercised early. See [Black-Scholes Model](https://learn.tradelabsai.com/options/black-scholes-model/) and [Binomial and Trinomial Trees](https://learn.tradelabsai.com/options/binomial-and-trinomial-trees/). ## Bid, ask and mid Options have a bid and an ask like any market. Spreads can be wide, especially for far out of the money strikes, distant expirations or less active underlyings. Buying at the ask and selling at the bid can cost a large share of the premium. - **Use limit orders** near the midpoint rather than market orders. See [Limit Orders](https://learn.tradelabsai.com/orders/limit-orders/). - **Prefer liquid options** with high volume and open interest. See [Options Open Interest Analysis](https://learn.tradelabsai.com/options/options-open-interest-analysis/). ## Premium for buyers and sellers - **Buyers** pay the premium and need the option to gain enough value to cover it. Time decay works against them. - **Sellers** collect the premium and profit if the option loses value. Time decay works for them, but they carry the risk of large moves. Selling premium tends to win often with occasional large losses; buying premium tends to lose often with occasional large wins. See [Theta Harvesting](https://learn.tradelabsai.com/options/theta-harvesting/). ## Common mistakes - **Judging options as cheap or expensive by dollar price** instead of by implied volatility. - **Ignoring the spread** on illiquid options. - **Buying options right before events** without considering volatility crush. ## Frequently asked questions ### What is an option premium? The price paid by the buyer to the seller for an option contract, quoted per unit of the underlying. ### What affects the price of an option? The underlying price, strike price, time to expiration, implied volatility, interest rates and dividends. ### Why do option premiums rise before earnings? Because traders expect bigger price moves, which raises implied volatility and therefore option prices. Next, learn how expiration dates work in [Option Expiration Dates](https://learn.tradelabsai.com/options/option-expiration-dates/). ## Continue learning - Next lesson: [Option Expiration Dates](https://learn.tradelabsai.com/options/option-expiration-dates/) - Previous lesson: [Strike Price](https://learn.tradelabsai.com/options/strike-price/) - Related: [Strike Price](https://learn.tradelabsai.com/options/strike-price/): The strike price is the fixed price at which an option can be exercised. Learn how strikes affect cost, probability and payoff, and how traders choose them. - Related: [Intrinsic and Extrinsic Value](https://learn.tradelabsai.com/options/intrinsic-and-extrinsic-value/): An option's price splits into intrinsic value and extrinsic or time value. Learn how to calculate each, what drives extrinsic value and why it decays to zero. - Related: [Implied Volatility (IV)](https://learn.tradelabsai.com/volatility/implied-volatility/): Implied volatility is the market's forecast of future movement, backed out from option prices. Learn how to read it, convert it to expected moves and use it. - Related: [Theta](https://learn.tradelabsai.com/options/theta/): Theta measures how much an option loses in value each day as time passes. Learn how decay speeds up near expiry and why sellers collect what buyers pay. - Related: [Black-Scholes Model](https://learn.tradelabsai.com/options/black-scholes-model/): The Black Scholes model prices European options from five inputs. Learn the formula, its assumptions, a step by step example and where the model breaks down. - Related: [The Option Greeks Explained](https://learn.tradelabsai.com/options/the-option-greeks-explained/): The option Greeks measure how an option's price responds to price, time, volatility and rates. Learn what each Greek means and how traders use them together.