Option Premium
Option Premium
The value of an option is also known as it’s ‘premium’.
This ‘premium’ is the amount that an investor can purchase - or sell - the option contract for.
When a trader wishes to buy the ‘right’ - but not the obligation - to purchase or sell a stock at a particular price by a certain date in the future, that trader will pay a premium for the option to the seller.
If the option contract winds up expiring worthless, then the seller of that option contract gets to keep the premium.
Depending on the volume of the underlying instrument, option premiums can have very narrow or quite wide bid / ask spreads.
Usually, the more volume and activity an underlying has, the tighter the options bid / ask/ spread.
The bid and ask prices are created / quoted by market makers whose job it is to make a market in that particular option.
The way market makers profit comes from their ability to buy at the bid price and sell at the offer price.
However, the retail trader doesn’t have this ability when buying / selling options and they will most likely be forced to buy closer to the offer price and/or sell closer to the bid price - or if they are lucky somewhere in between these two levels.
