DEFINITION of 'Step Premium'

A type of option where the cost of purchasing the option is paid gradually as the strike approaches instead of when the trade is initiated. The options contract spells out how much premium must be paid and when. A step premium option is more expensive than a plain vanilla in-the-money option, but less expensive than a contingent premium option. With the latter, the investor does not pay a premium if the option expires out of the money.

BREAKING DOWN 'Step Premium'

A step premium option is considered a structured option. A wide variety of options exist to meet different investment needs, and their premiums reflect the unique risks and rewards associated with each type of option. Investors like options because they offer a cost-efficient way to invest in an underlying asset, they can reduce investment risk when used correctly, they allow the potential for higher percentage returns by using leverage and they provide the flexibility to develop numerous trading strategies.

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