What makes up the premium
Formula
Premium = intrinsic value + time value. Intrinsic value is what the option would be worth if exercised now; time value is the rest.| Factor | Effect on a call's premium | Effect on a put's premium |
|---|---|---|
| Underlying rises | Up | Down |
| Higher implied volatility | Up | Up |
| Less time to expiry | Down | Down |
| Higher interest rates | Slightly up | Slightly down |
The Greeks measure each effect: delta for price, vega for volatility, theta for time and rho for interest rates.
An example
Example
With Nifty at 25,000, 12 days to expiry, implied volatility of 14% and an interest rate of 6.5%, the 25,000 call is worth about ₹280.50 and the 25,000 put about ₹227.10. Both are at the money, so their whole premium is time value. One lot of 65 units of the call costs 65 × 280.50 = ₹18,232.50.If Nifty were unchanged with one day left, the model value of the same call would fall to about ₹75. This loss of time value is called time decay, or theta.
Buyers and sellers
- The buyer pays the premium upfront. The most a buyer can lose is the premium.
- The seller receives the premium but takes on the obligation. The seller's loss can be much larger than the premium, so sellers pay margin.
Premium and implied volatility
The market sets the premium through trading. Implied volatility is the volatility that, put into a pricing model, gives today's premium. When IV is high, options are expensive; when it is low, they are cheap. The Black-Scholes calculator shows how each input changes the price.
Related terms
Learn more
Frequently asked questions
Is the premium paid per lot or per unit?
Quoted per unit, paid for whole lots. A premium of ₹280.50 on a 65-unit lot costs ₹18,232.50.
Why do option premiums fall on expiry day?
Time value runs out. At expiry, an option is worth only its intrinsic value.
Who receives the premium?
The option seller.
Trading involves substantial risk. Model prices on this page are examples, not quotes, and are not investment advice.