Tackle Today: Breaking Down Options Premium

«P = IV + EV»

Traders,

Every option, call or put, comes with a price tag. It’s known as an option’s premium. Understanding what drives the premium is essential to making educated decisions as a trader. Here’s the formula to remember:

Premium = Intrinsic Value + Extrinsic Value

In other words, P = IV + EV.

Intrinsic value is how much the option is in-the-money (ITM). The deeper ITM the option, the higher its premium. Out-of-the-money options have no intrinsic value.

Extrinsic value is how much you pay for time and volatility. The more time to expiration and the higher the expected volatility, the higher the premium.

Most options chains allow you to plot intrinsic & extrinsic values as columns. Do that for a few weeks as you build trades, and the relationship between Premium, IV, and EV will become intuitive.

In Wednesday’s Jedi Options segment, Coach Tyler explained how an options premium works. You can catch the replay here.


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