What is options premium?

 

Video Transcription

Hello again. Casey Jensen here at OptionsANIMAL. Now we're discussing options premium.

So how does options premium work in the Stock Market? Well, let's say a stock is trading at 35, and you want to buy a call option. So if we choose strike price 45, what you're buying is the right to buy the stock at 45, within a set time frame, let's just say it's maybe three months. And the stock has good earnings, they gap up. Maybe they're trading at 50. Well, you have the right to buy them at 45. So that should cost you some money, so what you look at here now is the bid is where we always sell, and the ask is where we always buy. So notice our ask price to buy that call option would be 55 cents. That's the premium that you pay to have this right to buy the stock at 45. And you could look at it from that same perspective when you're trading puts for the sake of understanding premium; I just wanted to focus the call options right here.

So now let's talk about a call option that you sell, and the premium associated with that. So let's say that you choose strike price 40 in this case. The stock's trading at 35. Now when we sell a call option, we're taking on the obligation to sell the stock at 40, so we should get paid for that. We're saying we're willing to cap our upside potential. We should get paid for that. There's that premium.

So notice, when we sell, we sell at the bid price. So premium is simply that 80 cents right there. And we would get to keep that 80 cents, you know, say that this contract was 90 days. If the stock is trading at $35.00 a share, 90 days later we get to keep that premium. And that's how that works, and we'll discuss some further videos, little bit more details into that strategy.