The option premium is the price paid by the buyer to the seller for the option contract. It's not a fixed amount and varies based on the moneyness of the option. Here are the key points:

• The buyer pays the premium amount to the seller in advance.

• The premium changes depending on the moneyness of the option.

• In-the-money options have a higher premium than out-of-the-money options.

• If the option moves more "in-the-money", the premium amount increases.

The premium reflects the market's assessment of the option's value, considering factors like the underlying asset's price, volatility, and time to expiration.

Important Note: Premium vs Brokerage

The premium amount paid for an options contract should not be confused with brokerage fees. Brokerage fees are paid to the broker for facilitating the transaction, whereas the premium is the amount paid by the buyer to the seller (writer) of the option.

Key Points:

• Only the buyer pays the premium.

• The buyer has the right, but not the obligation, to exercise the option.

• The seller (writer) is obligated to perform if the buyer exercises the option.

• The seller takes on a risky position, and the premium is the compensation for this risk.

• The buyer always pays the premium to the seller.

An option's premium has two parts: intrinsic value and extrinsic (or time) value. Intrinsic value is the difference between the spot price and strike price but only applies to in-the-money options. Extrinsic value is the additional amount an option buyer pays for the possibility of the option becoming more profitable before expiry.

In the example, the Infosys call option with a strike price of 950 has an intrinsic value of Rs.50 (Rs.1000 - Rs.950) and an extrinsic value of Rs.20 (Rs.70 - Rs.50). The extrinsic value reflects the probability of the option becoming more profitable before expiry, which decreases as time to expiry reduces. Two factors determine extrinsic value: stock price volatility and time left before expiry.

The option premium consists of two components:

• Intrinsic Value: The difference between the strike price and spot price, applicable only to in-the-money options.

• Extrinsic Value (Time Value): The additional value attributed to the probability of the option becoming more profitable before expiry.

Using the Infosys example:

• Share price: Rs. 1000

• Call option strike price: Rs. 950

• Premium: Rs. 70

• Intrinsic Value: Rs. 50 (Spot price - Strike price)

• Extrinsic Value (Time Value): Rs. 20

The time value reflects the possibility of the option becoming more profitable before expiry, influenced by:

• Time to Expiry: Longer time increases the probability of profit, while shorter time reduces it.

• Volatility: The possibility of the stock price increasing or decreasing.

The time value represents the extra amount a buyer pays for potential price increases or the risk premium charged by the seller (writer).

Important Tips:

• The option buyer pays the premium to the writer in advance.

• The premium is a separate payment from brokerage fees.

• The premium is paid regardless of whether the option is exercised or not.

• As the expiry date approaches, the time value of the option decreases and becomes zero on expiry.

• Out-of-the-money options have no intrinsic value, so the time value equals the option price.

• High volatility in the stock leads to high time value.

• Call options with different strike prices but the same expiry date will have different time values based on their proximity to being "in-the-money".

• Dividend declarations and interest rates also impact the premium.