Option Premium
The market price of an options contract, consisting of intrinsic value and time value.
What is Option Premium?
The option premium is the price a buyer pays (and a seller receives) to enter into an options contract. It represents the total value of the option in the market and is composed of two parts: intrinsic value (the immediate exercise value for in-the-money options) and time value (the additional amount reflecting the probability of becoming more valuable before expiration). The premium is influenced by the six key inputs of the Black-Scholes model: the underlying asset price, the strike price, time to expiration, risk-free interest rate, dividends, and implied volatility. Of these, implied volatility and time to expiration typically have the largest practical impact on day-to-day premium changes.
Example
A call option on a stock at $100 with a strike of $95 and 30 days to expiration trades at a premium of $7.50. The intrinsic value is $5.00 (the stock is $5 in the money). The remaining $2.50 is time value, reflecting the probability that the option will gain more intrinsic value before expiration. As expiration approaches, time value decays — a phenomenon measured by theta.
Source: CFA Institute — Options Pricing