🎯 What is Premium in Options? (Simple Definition)
Premium is the price you pay to buy an option contract. It's the total cost of your option and represents your maximum loss if the option expires worthless.
Think of premium like the price of insurance. You pay a premium to get protection (right to buy/sell). If nothing happens (option expires OTM), you lose the premium. If something happens (option goes ITM), you get benefits.
Example: If Nifty 22,000 Call premium is ₹150 per lot, and lot size is 50, your total cost = ₹150 × 50 = ₹7,500. This ₹7,500 is your maximum loss.
💰 How Premium is Calculated
Premium Formula:
Premium = Intrinsic Value + Extrinsic Value (Time Value)
Intrinsic Value: Real value based on current price vs strike
Extrinsic Value: Time value + volatility premium
Total Premium: What you actually pay
📊 Intrinsic Value vs Extrinsic Value
✅ Intrinsic Value
Real, tangible value based on current price.
- • Call: Max(0, Spot - Strike)
- • Put: Max(0, Strike - Spot)
- • Only exists for ITM options
- • Example: Nifty at 22,200, Strike 22,000 Call has ₹200 intrinsic value
⏰ Extrinsic Value (Time Value)
Value based on time and volatility.
- • Decreases as expiry approaches
- • Higher in volatile markets
- • Exists for all options
- • Example: ₹150 premium - ₹200 intrinsic = ₹0 extrinsic (if ITM)
📈 Factors Affecting Options Premium
1. Current Price vs Strike Price
ITM options have higher premium (intrinsic value). OTM options have lower premium (only time value).
2. Time to Expiry
More time = Higher premium. Less time = Lower premium (time decay).
3. Volatility (IV)
High volatility = Higher premium. Low volatility = Lower premium. Volatility is the market's expectation of price movement.
4. Interest Rates
Higher interest rates = Higher Call premium, Lower Put premium (less impact in India).
💡 How to Reduce Premium Cost
1. Buy OTM Options
OTM options have lower premium but need bigger price moves to profit.
2. Buy Longer Expiry
While longer expiry costs more, premium per day is lower. Better value.
3. Wait for Low Volatility
Buy options when IV is low. Premiums are cheaper during calm markets.
❓ Frequently Asked Questions
What is the difference between premium and strike price?
Strike price is the fixed price at which you can buy/sell. Premium is the price you pay to buy the option contract. They're completely different.
Why is premium higher for ITM options?
ITM options have intrinsic value (real value) plus time value. OTM options only have time value, so they're cheaper.
Can premium go to zero?
Yes! If an option expires out-of-the-money, premium goes to zero. You lose the entire premium paid.
How is premium decided in options?
Premium is determined by market forces (supply and demand), based on intrinsic value, time to expiry, volatility, and interest rates. It's not fixed by exchanges.
Understand Premium with Real Examples
Practice options trading on Zerroday and see how premium changes with market conditions. Learn premium calculation with AI feedback.
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