What is an Options Premium?

Sometimes referred to as an options price, an options premium can refer to two different scenarios in the investment market. Often, the term has to do with the amount of income or return that is generated when an investor chooses to sell an option contract to another investor. A different scenario focuses on the most recent price per share of a specific contract that has not yet expired.

With situations in which an investor chooses to write or sell some type of options contract, the options premium represents the income generated from the sale. That options contract may be in the form of a covered call or a covered put. In either case, the investor receives funds that he or she can then use to engage in other investment activity that will hopefully result in increasing the overall value of the investment portfolio.

The use of the term options premium has to do with the current price of any given investment option, based on several factors related to the underlying asset that supports the option. This includes the intrinsic value of that underlying asset, and the degree of risk that is associated with that asset. The projection of time value, or the amount of time remaining before the option reaches its expiration date is also an important consideration. Typically, the time value will begin to move closer to zero as the expiration date of the option approaches. At the same time, the intrinsic value of the asset will be in close range to the difference between the strike price of the options contract and the price of the underlying asset or security.

Understanding the options premium associated with any given investment opportunity requires that investors look closely at the current status of that investment and the direction that security can reasonably be expected to take within a given period of time. This is true not only for the investor who is seeking to write or sell and option, but also the investor who is considering the purchase of that option. By accurately projecting the future movement of that investment, it is easier to determine if the transaction should be a covered put or a call in order to earn the highest level of return. Should the investment perform as anticipated and the options premium is realized, the outcome is a greater degree of return for the effort, which in turn means the value of the investment portfolio is enhanced.