What Is an Option Premium? | How Do Options Work?

The premium is the price of an option: what the buyer pays and the writer (seller) receives for the contract. It is quoted per share, so for a standard contract covering 100 shares, the cash that changes hands is the quoted premium times 100.

In short: the premium is the market price of an option. It is made of intrinsic value (what the option would be worth if exercised right now) plus time value (what the market will pay for the remaining chance of a better outcome). For a buyer it is the maximum loss; for a writer it is the maximum gain.

How it is quoted

An options chain might show a Maple Widgets Inc. (a hypothetical company) $50 call at $2.50. That is $2.50 per share. Because one contract covers 100 shares (the contract multiplier), buying one contract costs $2.50 x 100 = $250, plus any commission. Writing one contract brings in $250.

Like any market price, the premium has a bid (what buyers are offering) and an ask (what sellers want). You usually buy near the ask and sell near the bid, and that gap is a real cost.

What it is made of

Every premium splits into two parts:

Part	Meaning	Maple Widgets at $52, $50 call priced at $3.40
Intrinsic value	Amount the option is in the money	$52 - $50 = $2.00
Time value	Everything above intrinsic value	$3.40 - $2.00 = $1.40

At expiration, time value is gone and the premium equals intrinsic value (or zero). What moves the premium before then, such as the stock price, time remaining, and implied volatility, is explained in how option premiums work.

What the premium means for each side

Buyer. Paying $250 for the call means the stock has to rise above $52.50 (strike plus premium) by expiration just to break even. The most the buyer can lose is the $250.

Writer. Receiving $250 is the most the writer of that call can make. In exchange, the writer takes on the obligation to sell 100 shares at $50 if assigned, and an uncovered call writer’s loss has no ceiling.

Common misunderstandings

“Collecting premium” is not free income. It is payment for taking on risk, and the risk can cost far more than the premium.
A cheap premium is not a bargain. Far out-of-the-money options are cheap because they usually expire worthless.
The premium is not the strike. The strike price is what you pay for the shares if you exercise; the premium is what you pay for the right.