How Is the Premium of an Options Contract Determined?

The premium is the price a buyer pays to the seller for the option contract. It is determined by two main components: intrinsic value and time value (extrinsic value).

Intrinsic value is the immediate profit if the option were exercised. Time value is influenced by the time remaining until expiration, the volatility of the underlying asset, the strike price, and prevailing interest rates.

The Black-Scholes model is a widely used theoretical framework for calculating this premium.