OPTION PREMIUMS
The premium is the price of the option that has been agreed upon by the buyer and the seller (writer). The premium is always quoted on a per share basis. The buyer of the option pays the premium to the seller to acquire the option and the rights that accompany it. For example, in February, a XYZ July 50 call option might have been traded at a premium of 3-1/2, meaning that the seller of that option would have received $350 for one option contract covering 100 shares of XYZ stock. In exchange for receiving this premium, the seller has agreed to deliver to the option buyer 100 shares of XYZ stock at $50 per share, if the option buyer exercises his right any time before or on the expiration date of the option contract.

The standardization of the exercise prices and the expiration dates means that the premium is the only variable to be negotiated in connection with the purchase or sale of the option contract. The premium is thus the centerpiece of the options market. Many writers of options consider the option premium as extra income. Most options buyers hope to purchase an option for a low premium and later, as the price of the underlying security moves in a direction favorable to their positions, to sell the option at a profit. Some option buyers hope that the price of the underlying security will rise above the exercise price of a call option held, or fall below the exercise price of a put option held, by an amount that allows them to realize a profit from the exercise of their options.

FACTORS AFFECTING OPTION PREMIUMS

Option premiums are affected by several factors, including:

• the current market price of the underlying security or index

• the exercise price of the option

• the time remaining until expiration

• the price volatility of the underlying security or index

• the dividend rate of an underlying stock

• prevailing market conditions and sentiment

  In general, as the market price of a stock (or the level of an index) increases, so does the premium of the call option. For example, if XYZ were trading at $99 per share, a call option with a strike (exercise) price of $100 with 5 weeks until expiration might have a premium of $4. But if XYZ were at $105, the premium might be $8. Here's why. The buyer of the call option has purchased the right to buy the stock at $100 anytime in the next 5 weeks. If the stock is at $99, it's obvious he won't exercise and purchase the stock for $100 when he could buy it in the marketplace for the cheaper price of $99. But if XYZ is at $105 and the call buyer has the right to purchase the stock at $100, there is already $5 of "built-in" value in the stock. The premium will have this $5 "built in" amount, plus additional amounts for the rights over the next five weeks.

  When the stock price is greater than the exercise price, the call option is said to have intrinsic value. This term simply means there is a tangible value to the option if it were exercised now. A call option is said to be "in the money" when it has intrinsic value. On the other hand, put option premiums generally increase as the stock price decreases. A put option has intrinsic value when the stock price drops below the exercise price.