An option premium is the price of the stock option. It is comprised of intrinsic value and time premium. The intrinsic value for a call option is the difference between the strike price and the stock price. For instance, if the stock price is $53, a $50 call option would have three dollars of intrinsic value. The time component is a function of the volatility of the stock, the time to expiration, dividends and interest rates. The Black-Scholes Model is the most common option pricing model. If a $50 call option was trading for five dollars and the stock was at $53, the time premium would be two dollars ($5 – $3 intrinsic value).
December 10, 2008