What is Options Premium? (Intrinsic vs. Extrinsic Value Explained)

When you buy a stock, the price you pay is simply the current market value of that company's shares. But when you trade options, you aren't buying the stock itself—you are buying a contract.

The price of that contract is called the Options Premium.

If you have ever looked at an options chain on your brokerage app and wondered why one Call option costs $50 while another costs $500, you are looking at the premium at work. Understanding exactly what makes up this price is the secret to avoiding beginner traps, like buying options that are practically guaranteed to lose money.

How Options Premium is Displayed

When you look at your brokerage app, the premium is usually displayed as a per-share price.

Because standard options contracts control 100 shares of stock, you must multiply the displayed premium by 100 to know your actual cost.

• If your app says the premium is $1.50, the contract will cost you $150.
• If your app says the premium is $5.00, the contract will cost you $500.

The Two Halves of an Options Premium

To understand why a premium costs what it does, you have to split it into two buckets.

Total Premium = Intrinsic Value + Extrinsic Value

1. Intrinsic Value (The "Real" Value)

Intrinsic value is the actual, tangible money the option would be worth if you exercised it right this exact second.

Let's say Apple (AAPL) is currently trading at $150 per share on the stock market.
You own a Call Option that gives you the right to buy Apple at $140 (your strike price).
Because your contract lets you buy the stock for $10 cheaper than the market price, your contract has an intrinsic value of $10.

If an option has intrinsic value, it is considered "In-The-Money" (ITM). If the strike price is worse than the current stock price, the intrinsic value is simply $0. It can never be negative.

2. Extrinsic Value (The "Time & Hope" Value)

If that Apple Call option has $10 of Intrinsic Value, why is your broker charging you $12 for the total premium?

That extra $2 is the Extrinsic Value. This is the price you pay for time and volatility.

Think of extrinsic value like paying a premium to live in an up-and-coming neighborhood. The house itself (intrinsic value) might only be worth $300,000, but you willingly pay $320,000 because you hope the new subway line being built next year will make the property skyrocket. You are paying extra for the potential of future time.

Extrinsic value is driven by two main factors:

• Time to Expiration: A contract that expires in 6 months has way more potential to make a massive move than a contract expiring tomorrow. Therefore, the 6-month contract will have a much higher extrinsic value (it costs more).
• Implied Volatility (IV): If a stock is completely unpredictable and swinging wildly (like during an earnings week), the potential for a massive move is high. The market will pump up the extrinsic value to account for this chaos.

The Silent Killer: Time Decay (Theta)

Here is the most important lesson for new options buyers: Extrinsic value is not permanent. Every single day that passes, the "time" portion of your premium slowly evaporates. This is known as Time Decay, or Theta.

If you buy an option that is completely Out-of-the-Money (meaning it has $0 intrinsic value), 100% of the premium you paid is extrinsic value. If the stock price doesn't move, your option will slowly bleed value every single day until it expires completely worthless at $0.

This is why Sell to Open vs Sell to Close is so popular. Option sellers love time decay because it slowly eats away at the premium they collected, allowing them to buy the contract back for pennies and keep the profit!