1. What is Option Premium?

Option premium is the price paid by the option buyer to the option seller for the rights conveyed by the option contract. It consists of two components: intrinsic value and time value.

2. How Does the Calculator Work?

The calculator uses the option premium formula:

Where:

• \( Intrinsic\ Value \) — The inherent value of the option if exercised immediately
• \( Time\ Value \) — The additional value based on the time remaining until expiration

Explanation: The intrinsic value represents the real monetary value of the option, while time value reflects the potential for the option to gain additional value before expiration.

3. Importance of Option Premium Calculation

Details: Accurate premium calculation is crucial for option traders to determine fair pricing, assess risk-reward ratios, and make informed trading decisions in the options market.

4. Using the Calculator

Tips: Enter the intrinsic value and time value in dollars. Both values must be non-negative numbers representing the respective components of the option premium.

5. Frequently Asked Questions (FAQ)

Q1: What determines intrinsic value?
A: Intrinsic value is determined by the difference between the underlying asset's price and the option's strike price. For call options, it's max(0, stock price - strike price). For put options, it's max(0, strike price - stock price).

Q2: What factors affect time value?
A: Time value is influenced by time until expiration, volatility of the underlying asset, interest rates, and the distance between the stock price and strike price.

Q3: Can option premium be negative?
A: No, option premium cannot be negative. Both intrinsic value and time value are always zero or positive.

Q4: How does volatility affect option premium?
A: Higher volatility increases time value (and thus premium) because there's a greater chance the option will move in-the-money before expiration.

Q5: What happens to time value as expiration approaches?
A: Time value decays as expiration approaches, with the decay accelerating in the final weeks before expiration (known as theta decay).