The option premium represents the current market price of an option contract. The option buyer pays this amount to the seller (or writer) in return for the right, without the obligation, to buy or sell the underlying asset at a predetermined price within a specific period.
The option premium has two components.
1) Intrinsic value: The value that the option will have if exercised immediately. It is the difference between the strike price and the price of the underlying. The intrinsic value of an option can never be negative, and this will be explored further in upcoming sessions.
2) Time Value: Is the part of the premium above the intrinsic value.
For example, consider a Nifty call option with a strike price of ₹24,500, expiring on 30 November 2024. Trading at ₹600 (Option Premium) as of 1st November 2024, when Nifty was trading at ₹25,000, the intrinsic value of this option is ₹500 (calculated as the difference between the current price and the strike price, i.e., ₹24,500 - ₹24,000). The remaining ₹100 represents the time value.
Why is the Option Premium Important?
The option premium helps you understand the cost of entering an options contract. Both the intrinsic value and time value play a role in determining how much you’ll need to pay for the option. As time goes on, the time value decreases, so it's important to keep an eye on how much time is left before the option expires.
In summary, the option premium is a combination of the intrinsic value (based on the current price of the underlying asset) and the time value (based on how much time is left until the option expires). Both of these factors are important when evaluating whether an option is worth purchasing and can influence how much you pay for it.
Disclaimer:This information is for educational purposes only. Trading in Futures and Options involves substantial risk and is unsuitable for all investors. Past performance is not indicative of future results. Consult a financial advisor before engaging in such trading activities.
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