💰 What is Options Premium?
Options premium is the price you pay to buy an option contract. It's the cost of the right (but not obligation) to buy or sell at a specific strike price.
Think of premium like the cost of an insurance policy. You pay a premium to protect your car - similarly, you pay a premium to buy an option that protects or gives you the right to trade at a specific price.
Key Point: Premium is your total investment when buying options. It's also your maximum loss - you can never lose more than the premium you paid.
🧩 Premium Components: Intrinsic Value + Time Value
Premium = Intrinsic Value + Time Value
1. Intrinsic Value
Definition: The actual profit if you exercise the option right now.
- • Call: Intrinsic = Current Price - Strike Price (if positive, else 0)
- • Put: Intrinsic = Strike Price - Current Price (if positive, else 0)
- • Only ITM options have intrinsic value
- • OTM and ATM options have zero intrinsic value
2. Time Value
Definition: The extra value due to time remaining until expiry.
- • Time Value = Premium - Intrinsic Value
- • All options have time value (even OTM options)
- • Decreases as expiry approaches (time decay)
- • Higher with more time to expiry
Example: Nifty 22,000 Call costs ₹200. If Nifty is at ₹22,100:
- • Intrinsic Value = ₹22,100 - ₹22,000 = ₹100
- • Time Value = ₹200 - ₹100 = ₹100
📊 Factors Affecting Options Premium
1. Underlying Price
Higher spot price = Higher Call premium, Lower Put premium
2. Strike Price
Closer to current price = Higher premium (ATM has highest time value)
3. Time to Expiry
More time = Higher premium. Premium decays as expiry nears
4. Implied Volatility (IV)
Higher IV = Higher premium. Market expects bigger price swings
5. Interest Rates
Higher rates = Slightly higher Call premium, lower Put premium
6. Dividends
Expected dividends = Lower Call premium, Higher Put premium
🧮 How Premium is Calculated
Options premium is calculated using mathematical models like Black-Scholes Model. You don't need to calculate it manually - your broker shows the premium in the options chain.
The key is understanding what affects premium so you can make smart trading decisions. Higher volatility, more time, and ITM strikes all increase premium.
⏰ Premium Decay (Theta / Time Decay)
What is Premium Decay?
Premium decreases as expiry approaches, even if the underlying price doesn't move. This is called time decay or Theta.
• Fast decay: Last 1-2 weeks before expiry
• Slow decay: Early in the option's life
• ATM options: Decay fastest (highest time value)
• ITM/OTM: Decay slower (less time value)
💡 Pro Tip: Avoid buying options with less than 7 days to expiry unless you're very experienced. Time decay will eat your premium fast!
❓ Frequently Asked Questions
What happens to premium at expiry?
At expiry, all time value disappears. Only intrinsic value remains (if any). ITM options have intrinsic value, OTM options expire worthless with zero premium.
Why do OTM options have premium if they have no intrinsic value?
OTM options have only time value. Traders pay premium because there's still time for price to move and make the option profitable. More time = Higher premium.
How much premium should I pay for an option?
There's no fixed amount. Compare premium to potential profit. Rule of thumb: Don't pay more than 2-3% of strike price for weekly options. Consider IV rank - buy when IV is low, sell when IV is high.
Can premium go to zero?
Yes! If an option expires OTM, premium becomes zero. Even before expiry, if the option is deep OTM with little time left, premium can approach zero.
Practice Understanding Premium
Watch premium changes in real-time on Zerroday. See how time decay, volatility, and price movements affect premium with live Nifty data.
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