Option Premium

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DEFINITION of 'Option Premium'

1. The income received by an investor who sells or "writes" an option contract to another party.

2. The current price of any specific option contract that has yet to expire. For stock options, the premium is quoted as a dollar amount per share and most contracts represent the commitment of 100 shares.

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BREAKING DOWN 'Option Premium'

1. Investors who "write" covered calls or puts use option premiums as a source of current income in line with a broader investment strategy to hedge all or a portion of a portfolio.

2. Option prices quoted on an exchange such as the Chicago Board Options Exchange (CBOE) are considered premiums as a rule because the options themselves have no underlying value. The components of an option premium include its intrinsic value, its time value and the implied volatility of the underlying asset. As the option nears its expiration date, the time value will edge closer and closer to $0, while the intrinsic value will closely represent the difference between the underlying security's price and the strike price of the contract.

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RELATED FAQS
  1. How is a short call used in a covered call option strategy?

    In a covered call strategy, a trader sells a short call at a strike price above the current price of the underlying stock. ... Read Full Answer >>
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    In a bear call spread option strategy, a short call option is sold at a lower strike price, while a call is bought at a higher ... Read Full Answer >>
  3. How can I generate a yield from stocks in the Internet sector that do not pay a dividend?

    To generate a yield from stocks in the Internet sector that do not pay dividends, traders can sell call options against their ... Read Full Answer >>
  4. What types of options positions create unlimited liability?

    Selling naked calls creates unlimited liability. Therefore, these types of option strategies are considered appropriate for ... Read Full Answer >>
  5. What is index option trading and how does it work?

    Index options are financial derivatives based on stock indices such as the S&P 500 or the Dow Jones Industrial Average. ... Read Full Answer >>
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