Definition
The premium is the price of an option — the amount the buyer pays and the seller receives for the contract. It is quoted per share, so a premium of 2.50 on a standard contract covering 100 shares costs 250 dollars total.
The premium has two components: intrinsic value, the amount by which the option is already in the money, and time value, the extra paid for the possibility that the option moves further into the money before expiration.
Why it matters
How it works
A premium is set by the market and approximated by pricing models that weigh the strike price, the underlying price, time to expiration, volatility, and interest rates. An at-the-money or out-of-the-money option carries pure time value, which erodes as expiration nears. An in-the-money option carries intrinsic value plus a shrinking time-value cushion. Buyers want premium to grow after entry; sellers want it to decay so they can keep what they collected. Comparing the quoted premium against a model's theoretical value tells a trader whether an option looks cheap or expensive.